September 26, 2022
At my law firm, we generally keep a close eye on commercial real estate markets because working with investors and developers represents a significant portion of our activities. When covid-19 hit, I saw it as accelerating the trend towards distributed workforces and remote work. Particularly in larger urban areas subject to high rent costs and long commutes. The proliferation of digital tools such as Zoom, and rising adoption rates for these new technologies as a matter of necessity during the pandemic, resulted in more companies getting comfortable with employees working remotely. It was also great for employees’ quality of life, eliminating the need for long daily commutes, leading to less stress and more free time.
Once companies have invested in digital platforms and trained employees on their use, they began to realize the upside. Not only were employees generally more satisfied being able to work remotely, but we are seeing ample literature pointing to gains in productivity. With significant numbers of people out of the office and their work continuing, that left a nagging question. Why spend a lot of money on expensive office space in central business districts? That level of expenditure no longer seemed necessary.
Having watched this unfold, my prediction was that in some markets we would start seeing increased vacancy rates as office leases started expiring. Instead of leasing ten floors in a building, companies would cut back to perhaps two floors, with a greater emphasis on shared and meeting space. In other words, support hybrid working environments where employees may only come into a physical office on a part time basis or for key meetings but spend most of their time working elsewhere. That thesis appears to be bearing out.
Bloomberg published an in-depth article today focused on commercial office buildings in Manhattan, stating that vacancies are creating a multi-billion-dollar problem for property owners as vacancies, particularly in older buildings rises, with little prospect of finding new tenants.
Remote Work Is Killing Manhattan’s Commercial Real Estate Market (bloomberg.com)
The article notes that many buildings are too new to be demolished for new uses yet are old enough to fail to attract tenants who, in lieu of more space, are seeking nicer properties with more amenities to support their distributed workforces. The prediction is for a long-term decline in demand. I concur with that assessment.
What does that mean for commercial office buildings? Investors will howl, but they will take a significant haircut, as will lenders, as rents will be unable to support debt service, operations, and maintenance. That means loan workouts, foreclosures, and ultimately, a re-pricing of properties in this asset class. It will take some time to shake out and, perhaps, this presents a longer-term opportunity to help address demand for housing. Time to start thinking about converting office buildings into high-rise apartments?