Archives for March 2021

New demand for office space in core markets—measured by tenant tours of properties across the country—increased by 21%, or seven index points, in January 2021, a rate that’s on par with previous years but still smaller than it was pre-pandemic. But recent research by VTS shows that local COVID-19 caseloads are no longer the same demand driver they were.

The VTS Office Demand Index shows that office demand nationally was at 40 index points, as compared to 99 points year-over-year. By way of comparison, demand activity was at 100 in January 2018, a time that was relatively stable for office leasing.

Markets hit hard by COVID typically experienced a dramatic bottoming out in early spring 2020, but those cities with the highest increase in cases over the last three months actually saw demand increase the most. VTS posits that demand in local markets is more related to hyperlocal near- and long-term factors like job growth, vaccine rollout, and public health safety measures.

West Coast cities like Seattle, San Francisco, and Los Angeles showed the greatest tenant demand growth, while Chicago and Boston had the least growth. San Francisco was the absolute lowest of all markets in 2020, with “almost no office tenant demand,” but showed the strongest growth from October to January with an increase of 162%. By the end of last month, the city had recovered 58% of the demand it lost early on in the pandemic and is second only to Los Angeles—a market that has a high percentage of creative industries that use office space—in a return to pre-COVID levels. In LA, demand is now down only 15% year-over-year whereas San Francisco is down 52% over the same period.

On the East Coast, Washington, D.C. is expected to see larger gains as the Biden Administration settles in, and modest growth in January helped turn the tides on the most dramatic slide in office demand during the fourth quarter. In New York City, marginal gains in office-using employment led to an 8 point increase in the index, but the city is the furthest from pre-COVID levels of all markets surveyed, at a 66% decrease year-over-year. Class A product and trophy space in Manhattan accounted for 82% of all toured space last month.

Many tenants are capitalizing on softening rent and snagging concessions as workers return, at least in part, to using offices. Leasing activity from September to November accounted for 50% of total volume last year, according to data from Zoominfo, thanks largely to corporate office expansions. Last year, 539 office-using companies expanded, with Amazon leading the growth in the sector.

“It was no surprise to see demand rise overall in January, as that happens every year, but looking at market-by-market trends shows us that employers are changing their focus,” said VTS CEO, Nick Romito. “Given the ups and downs of COVID-19 cases are having less impact on office demand, many employers are now making long-term decisions rooted in the mental and physical health of their workforce, office culture goals and the local economic and leasing climate. All that said, we are still quite far from a full recovery.”

Source: “COVID-19 No Longer Main Driver Of Office Demand”

If work-from-home trends stick after the pandemic, it could cause a permanent decline in demand for space and have a severe impact on property values, according to Fitch Ratings.

Fitch ran various stress scenarios to determine how telework would impact demand, rent and net cash flow on 2012-2020 vintage office CMBS transactions. Under scenarios of moderate and severe stresses, it found that 4.4% and zero, respectively, of 114 US CMBS office single-asset/single-borrower bonds maintain their current ratings.

Under its moderate stress scenario, Fitch assumes that employees will work remotely 1.5 days per week. That would result in a 20% decline in office workers and a 10% decline in office space demand. Fitch’s severe scenario doubles these assumptions. It assumes that rents decline at 1.25 times the reduction in space. In this occurrence, increased vacancies magnify declines in rent levels.

Under the moderate and severe scenarios, net cash flow declines 15% and 30%, respectively. Fitch assumes cap rates from its most recent surveillance review of 7.23% on average with these two scenarios. Those rates are significantly higher than the 4.73% appraisal cap rates at loan origination.

Using those assumptions, Fitch saw average market-value declines from at-origination appraised values of approximately 44% and 54%, respectively, for moderate and severe scenarios. If those declines occurred, 25% and 55% of investment-grade bonds could potentially fall below investment-grade under the moderate and severe scenarios, respectively. Already, property values fell by 38% on average in Fitch’s current rating analysis.

For comparison, office property values fell approximately 43% during the 2008 Great Recession. They recovered over three years. With a possible secular shift to working from home, values could take a lot longer to recover following this recession.

What ultimately determines if values will fall and how much is whether workers return to the office.

In a segment on CNBC’s ‘Squawk on the Street,’ Brett White, Cushman & Wakefield’s CEO and executive chairman, said the number of people working from home could double from 5% to 10%.

An additional 30% of office workers were allowed to work from home one or two days a week. White thinks that number will jump 50% to 60% after the pandemic. Additionally, 3 million workers lost their jobs in March and April and only 1.8 million have been rehired.

Overall, he could see companies with these agile workforces reduce their footprint by 10%, 15% or even 30%.

“A lot of employers should and will think of creative ways to use their space more efficiently,” White says. “And that’s going to be a drag on occupancy.”

Source: “Stress Tests Reveal Office Values Could Fall 50% if WFH Sticks”