The post-Labor Day return to the office has begun — or has it?
Several companies, including Apple Inc., are, once again, using the end-of-summer holiday to require employees to come back to the office at least a couple of days a week, as the pandemic’s limitations on in-person activities further wanes.
It’s the hope of many in commercial real estate that, finally, the tide will turn for the U.S. office market, which has yet to recover from the pandemic. But whether it will remains very much to be seen.
A survey conducted Aug. 1-5 by PricewaterhouseCoopers LLP, a London-based professional-services firm, found 22% of companies are scaling back their investment in real estate. That’s more than any other business area. Seventy percent of survey respondents said they’ve expanded or have plans to expand permanent remote-work options for roles that allow it, with 42% having already implemented such measures.
All this is sure to have a ripple effect on the office market — even if more people are working in the office this week.
The Business Journals caught up with Byron Carlock, real estate leader at PwC U.S., about the survey and general sentiment in commercial real estate, especially as the threat of a recession looms. The following excerpts have been edited for brevity and clarity.
How are things feeling right now in the commercial real estate world?
Broadly speaking, there seems to be a disconnect between Wall Street and Main Street. The capital markets have certainly tightened for real estate yet demand is still pretty strong, especially for housing. You see record rents being set in New York, as an example. On the housing side, I think we are probably still relatively undersupplied to meet current demand in housing — multifamily landlords, especially, are giving pretty significant rent increases because demand is high and supply is pretty tight. Retail is continuing its transformation and the consumer is still spending, although we are reading about credit card debt climbing again … spending to maintain a lifestyle as wages are flattening and take-home income is being impacted by higher costs.
Industrial is still in higher demand, especially in the major distribution markets, but the major question mark is around office … (there are) different responses based on the company’s need for talent. Most enlightened users are allowing remote and in-office expectations … the magic number (might be) three days in and two days remote … but the enlightened users are changing the way they use their space to make it more conversational, collaborative, more sofas and seating areas, fewer cubicles, bigger conference spaces, more (audio and video) equipment so people can Zoom in, moving meetings to the metaverse so you feel like you’re in a meeting with (them).
Then you have the belt-tighteners, which is especially becoming evident at renewal time. It looks like the sublease overhang is beginning to thin down a little bit in most of the major markets but people (are viewing) rent and occupancy costs (as) an opportunity as we enter a recession — hopefully a mild one.
You say the office sector remains a big question market, a sentiment heard everywhere right now. What might be some of the major differentiators for how office real estate fares in the coming years? Do companies see reducing or eliminating real estate as an important cost-cutting measure with “recession” in headlines everywhere?
I think the watchword is relevance. You have to think about how it’s relevant to operational needs and place in the war for talent. It’s key on a couple of dimensions: cool spaces still attract people. Enlightened users are spending time making their space attractive for talent, hiring and retention, mentoring and gathering.
The belt-tighteners are truly looking to cut costs, and office space is an easy one, but there’s a differential related to buildings (that are) good for the long term and those that may be losing relevance, and those decisions to reduce space become easier.
About 80% of (the U.S.’s) office stock was built in the ’80s or before, and the growth of (environmental, social and corporate governance) is really pushing people into higher-quality uses. The A and A-plus buildings, especially the ones relevant to the highest ESG measures, are getting the best occupancy … others are having to be repurposed or demolished. As we look at this next cycle of development and redevelopment, this is an opportunity to rebuild. ESG (will be a) litmus test to which stay and which go.
Can you talk more about the ESG element and why that is becoming so relevant?
Investors and users are demanding higher levels of ESG compliance. The (U.S. Securities and Exchange Commission) is about to require all companies to disclose certain ESG-related measures alongside their financial statements. We are behind Europe on what we require — (some countries) give environmental scores; if they (don’t meet standards), they can’t be leased or sold.
There’s a fear about the brown-building discount if it doesn’t meet certain minimum environmental standards. Investors and landlords are really focusing on improvement opportunities to bring buildings to higher levels of ESG compliance or repurposed for other uses.
It’s an important issue as we react to climate change. The technology is rising to the occasion quickly … the Inflation Reduction Act has some interesting energy incentives I think you’ll see more owners use as we make our buildings more ESG-compliant. That’s going to be a big line of demarcation of buildings that are relevant (and those that are not).
If so much of the national office stock was built before the 1980s, is it realistic to think a lot of them will be brought into 21st-century ESG standards? Will this prompt more redevelopment or demolition?
It’s a hard decision to make for landlords and owners, but we’re also looking at repurposing our built environment in most of our major cities as we think about the interaction between good, healthy buildings, green space, walkability — some buildings have lost that relevance. They either need to be redeveloped or, in more draconian situations, demolished.
The spaces that meet relevant needs will do just fine — (look at) the raging success of the One Vanderbilt building in Manhattan, (which is) signing record lease rates at a time when some buildings are struggling. I think the issue is what is relevant to the workforce standards? We saw this coming out of the ’70s, when you think about some of the Brutalist architecture of buildings built in the ’50s to ’70s that lost their relevance. They were either repurposed or demolished. Now some of those (replacement buildings) have lost relevance. They are ripe candidates for conversion to multifamily or hotels.
Are you seeing a lot of capital being raised to prepare for an onslaught of distress in commercial real estate, whether office or otherwise?
We’ve had 10 good years in this cycle. There is talk of this recession tipping some buildings into the opportunistic category, where one person’s difficulties become another person’s opportunities.
There’s plenty of opportunistic dry power out there now … and still waiting to be deployed. As far as raising new money, there is ongoing money being raised. I would say the bulk of that appears to be in the value-add category, which tilts toward opportunistic, but it also takes advantage of the opportunity to make a better environmental play, and often a cost play, by repurposing an existing structure than building ground up from zero. There is a heightened desire to repurpose what can be repurposed and make it relevant.
Value-add opportunity will be a theme that we’ll see over the next couple of years as we experience this hopefully short-term recession.
Your survey found 30% of respondents in financial services plan to decrease their investment in real estate. Is it notable that financial companies are seemingly especially looking to cut back on real estate, given that they’ve been heavy users of office space historically?
I think it’s thematic and has been going on for some time. The big users of space have been more tech-oriented in the past five years. Financial services, accounting and legal have been reducing their space needs for quite some time.
I think the reason you see that in the financial services sector in this particular survey is … (for example,) mortgage lenders (are seeing) layoffs. (Financial technology) is just not as people-intensive as it once was. Technology is replacing people in financial services.
What regions are at the biggest risk for commercial real estate-related issues?
Our Emerging Trends in Real Estate report comes out in October. There is real concern about the issues of certain cities, and it looks like the biggest concerns are going to be Chicago and San Francisco. It’s too early to say but I think the issues associated with safety, quality of life, culture, walkability, livability continue to move people into the Sun Belt/Smile states, the business-friendly states, at the expense of more mature cities — many of which have been more active in the issues associated with safety.
I think it’s going to be an important time for city leaders to rise up to the occasion, to face some of the darkest issues of crime and safety.
I’m hearing that concern voiced especially in investment planning. The gauntlet falls on city and business leaders that are having the biggest issues. San Francisco certainly comes to mind. There’s so much wealth in the Bay Area, and the tech industry is so interested in seeing these things improve, and people in the tech bent want to be in the Bay Area because it’s such a mecca for entrepreneurship. But if you walk the streets of San Francisco any day or night, it’s concerning. You contrast that with the vibrance of some of the second- or third-tier cities – Dallas-Fort Worth continues to lead the nation in corporation relocations, Austin, Atlanta, Raleigh-Durham, Charlotte, even Greensboro.
Some have postulated, if we enter a recession and the labor market loosens, employers will have more leverage and get stricter about in-office requirements. What do you think?
I think that the pandemic has probably introduced remote working for quite some time to come. The dynamic between employees and employers … will continue to shift as we dip into a recession. But even decision-makers are learning to appreciate some level of flexibility in remote working because productivity is so much higher. We saw very, very clear increases in productivity, and there’s technology to make sure your people working remotely are working — keystroke monitoring, regular review/feedback sessions. The overwhelming belief is this flexibility we’ve learned about … (will be considered) longer term. (But) there’s no substitute for being in a room with a whiteboard (for planning and collaboration). I’m going to stand by the story that it’s both and not an either-or.
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