Smith and Howard would like to thank Ryanne Pennington of Jones Lang LaSalle and Chris Schoen of Greenstone Properties for participating in this article and sharing their insights with us.
There is no doubt that the COVID-19 pandemic has significantly affected office real estate around the country. As businesses begin welcoming their employees back to the office, many of those spaces remain sparsely occupied. Will that trend continue in 2021 and beyond? Smith and Howard spoke with two industry experts to get their perspective on the current office real estate environment and what they anticipate in the office market of the future.
Demand for space in the current environment
Most people do not believe the full corporate office is a thing of the past. It has, however, undergone a dramatic change and will continue to evolve in the coming years. One fallout from this trend is likely to be the demand for office space. Ryanne Pennington, Executive Vice President at Jones Lang LaSalle Inc. (JLL) in Atlanta, says that across the country, the majority of demand for office space is in a state of pause. “We expect some degree of rebound (in demand for office space) in Q3 and Q4 as businesses roll out their first and second re-entry plans, although there may be some additional lag due to health concerns or macroeconomic uncertainty.” She said that Atlanta’s status as a relatively affordable, low-density market that is not dominated by public transportation bodes well for the office real estate market as employers plan their return to work strategies.
While some businesses have delayed a full return to normal operations, notable companies like Microsoft and Walmart Labs have announced plans to expand to higher-profile submarkets (Midtown Atlanta and Reston, Virginia for Microsoft), suggesting that some businesses are continuing to grow and will require additional office real estate despite the work from home trend.
Chris Schoen, Partner at Greenstone Properties, Inc., estimates that in July, fewer than 20% of companies were back in their space at an occupancy level greater than 30% of their previous capacity. “Most companies have given tremendous leeway to people dictating if they will work from home or not and most people are continuing to do so, especially given that the country is still seeing new cases at such a (high) rate. As many companies do come back to the office, I do think you will see some fundamental changes in space layout, square footage per person, common areas and so on. For those companies that can do it, you will probably also see a staggering of the work week so that not greater than 50% of the work force is at the office at any one time,” he said.
Pennington pointed out that there is general consensus about how being in an office leads to better collaboration, camaraderie and productivity. She believes that future job creation and decreased density of office space will provide a counterbalance to the impact of expanded work-from-home programs, with the caveat that it may be 24 to 36 months before that balance is realized.
What to consider if renewing a lease
Even as more employees return to corporate offices over the next two to three years, worries about exposure to the virus may remain. With that in mind, corporate leaders need to decide if they should remain in their current office space and make modifications to accommodate health guidelines or move to new space that better suits their needs.
“Covid-19 has forever changed how we work, where we work and the relationships between the office space, employees and employers. Now is the time to reimagine your organization’s strategy through a new lens, where the importance of real estate and your employees are top of mind. When evaluating an upcoming lease renewal, it is important to look at your office lease(s) holistically,” Pennington advised. Among the things she suggests decision-makers should consider:
“In many cases, those answers are leading our clients towards more flexibility and adaptability in both the lease terms and the space occupied,” she said.
Rental rates over the next 12 months
Where do property experts see rental rates for office space going in the next 12 months? Will the current work-from-home environment created by the pandemic result in empty office space and falling rent? Not necessarily. Pennington says that Atlanta has seen a slight decrease in rental rates to date, with the second quarter seeing a drop of about 70 cents per square foot from the first quarter of 2020. “We know that historically, Atlanta has fared better than other primary markets and the nation. Average rent, which saw declines of 8.2% over the last two recessions, returned to previous peaks in roughly six years. Understanding each building owner’s investment strategy will allow occupiers and owners to achieve the best financial results together,” as opposed to relying on market ‘norms’ or short-term trends, she explained.
Is new construction better and healthier?
Just as some businesses will be thinking about lease renewals, there are also those who have been eyeing new office space. Schoen says that previously, corporations had been driving square footage per person to lower and lower numbers. Now, he says, “I think you will see a fundamental change in that. Previous square footage per person will, at a minimum, double.”
When it comes to leasing costs tied to new construction (as of 2020), Schoen says, “We haven’t seen the cost of construction decrease in any significant way. As such, new construction is going to continue to go up and, therefore, rents will have to keep pace to justify that new construction.” Explaining the reason for the expected increase in pricing, he said that some new construction will potentially have its cost increased if a significant amount of health measures needs to be added to buildings as a result of the pandemic. “We have looked at upgrading air filters, increasing outside air intakes and installing ultraviolet inside air handling units on projects that we have under construction, just by way of example.”
Pennington said that occupiers who are able to think strategically and long term will be able to capitalize on reduced economics and increased concessions, such as free rent and tenant improvement allowances in their current space. “Atlanta has seen a significant increase in activity, with technology companies betting big on Atlanta’s talent, low cost of living and diverse ecosystem. The majority of these announcements have been in new construction building, signaling to the market place that high quality buildings, environmentally sound construction and new building practices are a trend that will continue long after Covid,” she said.
What will the ‘office of the future’ look like?
Pennington believes the office of the future will have an increased focus on health and wellness and flexible work environments. “Flexible work-from-home arrangements are likely here to stay in the short- to mid-term, though many companies, and their employees, are experiencing a decline in productivity and are anxious to return to the office for the social and collaborative benefits it offers. Innovation and culture are difficult to grow over Zoom, and tenants and their employees report missing human interaction. We are seeing companies and employees embrace the idea of mobility and desk sharing as a way to reduce costs and support partial remote work.”
Schoen thinks we will see some significant changes to HVAC systems, as he outlined earlier when discussing new construction. Additionally, “I think you will see ‘touchless’ building entry where, by way of example, your security card allows you to enter the parking deck, opens the parking deck elevator lobby for you and calls the elevator, delivers you to the lobby or specific floor and opens your tenant door for you, all while touching nothing. Cleaning and cleaning systems will evolve as well.”
Where do we go from here?
JLL has clients across the country and world, which gives them a global perspective. As Pennington points out, each market is unique, but she believes that in the U.S., the Sun Belt markets (the southern tier of the U.S.) that were powerhouses in the quarters leading up to the onset of the pandemic will continue to lead the recovery.
“Demographic and economic trends were working in our favor pre-COVID,” Pennington said. She pointed out that Atlanta, Nashville and Charlotte attracted business from higher-cost markets because they offered a business-friendly tax and political environment, access to highly qualified talent based on the strength of their universities, comparatively low cost of living and low cost of doing business. “Those drivers of economic growth will continue post-COVID,” Pennington predicted. “Cost is increasingly important, so companies whose portfolios are overleveraged in higher-cost markets on the coasts, or in the Midwest, may look to the Sun Belt markets for new expansions and relocations.”
CEOs have many things to consider in the coming months and years when it comes to ensuring their employees feel the office is a healthy one. While technology has allowed people to work from home efficiently, it is clear that many miss the camaraderie and energy that comes from interacting with their colleagues in person and that businesses want to continue to focus on culture. Adopting some of the measures Schoen highlighted may help make the corporate office a healthy environment for employees and encourage them to return.
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