Commercial Office Sector: The New Paradigm
With a new year, there is always the general hope for better days ahead and the anticipation of exciting things to come. Following what can only be described as an unprecedented year filled with innumerable challenges, this is especially true, and the world at large is eager for a return to normalcy. What “normal” actually means is yet to be truly understood, but there is real reason for hope with the remarkable developments on both the virus therapy and vaccine fronts, and the ongoing global vaccination push. While there will clearly be lasting repercussions from COVID-19, most will prove to be positive in the long term; however, some will represent obstacles in the near to intermediate term. As the saying “with adversity comes opportunity” suggests, the future is ripe with opportunity for those who embrace change.
No place is this more true than the commercial office sector.
Forced work-from-home has not only redefined the feasible ways for how people work, but it has challenged the conventional notions of required in-office productivity. As a result, the workplace is poised for significant transformation. Hybrid work models that allow for both work-from-home and the office are expected to become more prevalent and the standard over time. To this end, several large companies across industries have publicly stated their intent to implement hybrid models. Companies’ openness to this change is being driven by a variety of factors, all of which continue to be reinforced as more time passes. These include:
- individuals’ newfound appreciation for the quality of life afforded by flexible work arrangements;
- companies’ growing comfortability with employee productivity outside the office;
- companies’ desire to retain and attract top employees with work flexibility touted as a key offered benefit; and
- companies’ interest in cutting unnecessary costs to drive/preserve their financial performance post-pandemic.
For the commercial office sector, a hybrid work model has profound implications.
While reduced office density will certainly be a lasting outcome of the pandemic, most industry experts do not think it will offset companies’ demand for office space on an absolute basis. In addition, the office space that companies do lease is expected to be more geographically dispersed, both within a metropolitical area (e.g. suburban satellite offices to complement urban offices) and across the country. This allows these companies to recruit the best talent without the constraints of traditional geographic boundaries. For most companies, this will mean a greater number of offices of smaller average size. This, in turn, will result in most office buildings being occupied by a greater number of tenants.
When these demand challenges are coupled with the significant amount of available space in most markets (vacant and subject to sublease), it is expected that rents will be under pressure for the foreseeable future and that companies will have the upper hand in lease negotiations. Additionally, most companies will have a strong preference for shorter term leases (2-5 years versus the traditional 7-10 years) due to both the high level of market uncertainty and their lack of visibility into future space requirements as they experiment with different hybrid models to find the optimal balance for their business. Lastly, companies will want to lease space in modern, attractive buildings that feature safe work environments and offer enhanced amenities and services that will make their employees comfortable and excited to come back to the office. This is essential for capturing the greater productivity that in-office work can offer through better relationship-building and collaboration.
While all these factors do not necessarily mean your average company will spend less on real estate-related expenses, it does mean these companies will have greater expectations regarding these expenses and will be viewed as an area for potential cuts as they continue to rationalize their business in a post-pandemic world.
So if hybrid work models are the new paradigm for companies, what is the required new paradigm for building owners?
Vacant space is the absolute killer for real estate investment returns, both in terms of reduced revenue and cost absorption. Thus building owners are faced with delivering an enhanced tenant experience at the competitive rates required to keep their buildings occupied (often lower than pre-pandemic rates). At the same time, operators will need to be adept in cutting costs to provide them the financial flexibility to be aggressive in retaining and attracting tenants, thereby minimizing the impact of these evolving market requirements on their returns.
While this may seem daunting, it would be helpful for office operators to remember how their peers at luxury hotels, such as the Four Seasons, compete for guests predominantly based on hospitality. While there will always be new hotels with fresher designs and the latest amenities, the leading luxury flag operators have built their brands and guest followings through superior customer service. This is the mental shift required for office owners to be successful in driving occupancy and commanding premium rents in this brave new world–certainly different from the connotations of conventional “tenant” and “landlord” roles. It is important to remember that even with the prospect of shorter-term leases becoming more prevalent, office building owners will still have the benefit of multi-year leases versus competing for customers on a nightly basis. For commercial offices, superior hospitality will mean flexibility on lease structures and space layouts, and enhanced tenant amenities and services. It will also mean that operators must acknowledge the growing prevalence of hybrid work models and advise their tenants accordingly.
Lastly, beyond the requirements for greater customer service and more efficient operations, operators will need to demonstrate to their tenants and investors (current and prospective) that they are actively executing on sound and progressive ESG strategies for promoting safe and productive work environments, while reducing the carbon footprint of their buildings. Operators should expect the bar to be raised for ESG from simple reporting to demonstrating a track record of continuous improvement.
To provide this level of service with the same amount of human resources, operators will need to embrace technology across all aspects of their business. Technology offers asset managers and their property teams the ability to enhance the experience they are offering their tenants and better address their evolving needs, while also reducing building operating costs and enhancing their ESG operating practices. Technology not only provides access to better tools, but it can also automate otherwise manual tasks, allowing these teams to be more nimble and better leverage their time in meeting these increased and ever-evolving requirements.
The key question is whether an operator is getting the desired benefit from their current solution providers and if these providers are providing them a true competitive advantage. Proper executive team commitment and oversight, including the removal of any institutional barriers to full adoption, is paramount for extracting maximum value from any technology. The second part– and arguably the most important–is the determination of whether a particular technology provides real, actionable value that unlocks the full potential of an owner’s portfolio and provides a meaningful competitive advantage versus other property owners in attracting tenants, driving returns, and accessing capital from top institutional investors.
If you enjoyed this post, you may also like to check out our video, which highlights the myriad of challenges facing commercial office owners and the key requirements for competing going forward.