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Guest blog: Covid has changed the office market forever

4/29/21 8:45 AM

We are now over a year into a pandemic-induced workplace (r)evolution. To no one’s surprise, views on the role of the office are still polarized. Within commercial real estate, many corporate leaders are hoping for a return to old ways of working. However, inflection points are simply part of life. Covid-19 is a huge inflection point for the office world. Now it’s the customer, both tenant companies and end-users who are in the spotlight, who will have their turn to write the next chapter of what it means to “go” to work. For those whose income and business model is tied to supplying or servicing the world of offices, a beginner’s mindset has become necessary, to survive.

Planning for safe return to office post-covid and the new ways of working that affect office space requirements.
There are resounding sentiments around scaling back and rethinking real estate footprints.

Creating the next chapter in the history of the office is not about being right or wrong. It’s about being brave in the face of change and pushing against everything about work, that in the past has had end-users feeling like offices are failing them. I can’t think of two more befitting quotes for the commercial real estate sector right now, than these:

“If it hurts to hear it, look for the truth in it. If it comforts to hear it, look for the lie in it.”
– Naval Ravikant

“If your mind is empty, it is always ready for anything, it is open to everything. In the beginner's mind there are many possibilities, but in the expert's mind there are few.”
– Shunryu Suzuki

I want to share some of my high-level observations, both from the vantage point of all the reading and studying I’ve been doing, and on the ground in Toronto (Canada) talking to customers, both companies and humans, this past year.

The job and office market has changed for good

Leading employers are now laser focused on the holistic wellbeing of their employee base, and are doubling down on obtaining the best talent, wherever it may reside. Employees, while all faced with a unique set of challenges are telegraphing that they will no longer seek work that tethers them to a singular, fixed location. These forces are giving rise to “location, location, location” getting redefined

At one end of the spectrum, an “unbundling” of the office seems to be taking shape. Leading examples include deals between IWG Group and Standard Chartered Bank & NTT, but there are also many others such as Dropbox, Spotify, Revolut and many more who are creating this structure within their own workspaces and are actively seeking partnerships with Space-as-a-Service operators. I hope that in addition to the burgeoning Space-as-a-Service sector, governments at the municipal, provincial and state level get involved to support bringing work to people, not people to work.

There is no return to the "traditional, normal office" work.The veil has been lifted: Smart companies know their employees are not willing to “snap back” to offices and the traditional paradigms of work and management, that existed pre-covid.

In this regard, I think there is a major gap on the supply side of commercial real estate to support local and distributed ways of working. I also think there is a massive need for a leader on the digital platform and a marketplace side to make transacting more seamless, and allow an employee to wake up and be able to say to themselves: “Where will I do my best work today?”

Technology has the opportunity to guide where work happens, maximize space utilization and encourage new ways of collaborating and building relationships. The “work-from-anywhere (WFA) movement” is growing like a weed, so it’ll be interesting to see who decides to ‘move where the puck is headed’ [classic Canadian ice hockey reference on strategy].

At the other end of the spectrum, I’m a big believer that amenity rich, transit-oriented areas of central business districts, CBD’s, will be more important than ever. While I do believe the 15-minute city and more local ways of working are on pace to become a way of life, I think it’s going to take time for the supply side to catch up and make it easier for companies to purchase office space in more decentralized and have fluid access to them in on-demand ways. Until then, I think a lot of companies will take less office space in the best areas and buildings in the CBD, and the rest will happen from home.

Distributed working 2.0 is here to stay

Barclays published a white paper which asserted that work-from-home (WFH) is here to stay, and are flagging a potential reduction in office space demand of as much as 20%, which while hotly contested by many, could be argued to be conservative. Impossible to refute at this point (April 2021) - but I am still partial to “WFA”, as “WFH” is too binary, and that isn’t where we all are headed.

iStock-WFH-with-dog_compressed
Employee productivity spend will increasingly migrate to the home, new office markets and new product types

CBRE Canada also made mention of a potential reduction in demand, by as much as 10% in our recent Canadian Market Outlook. Using Toronto as an example, we illustrated what the impact on vacancy would be if we assumed a reduction of 10% in total demand because of on-going distributed work behaviors. The result was a potential increase of 400 bps in the vacancy rate. The question will become, is this structural vacancy (i.e. it never rebounds) or is it impermanent? No one knows for sure, but there is some smart money betting on a permanent reduction to demand.

Either way, I can’t see any downsides for landlords to assume this is true and start to plan how they can make their buildings “stickier” for the end-users. And, as any reduction in demand won’t be linear, some buildings could literally become obsolete without a major overhaul (others, of course, should be repurposed regardless). Anecdotally, I also haven’t spoken to a single customer who isn’t talking about downsizing and reimagining their office footprint.

The long-term lease could become outdated

According to Bloomberg, after scraping 4,700 earnings calls, there are resounding sentiments around scaling back and rethinking real estate footprints. Every day there continue to be more and more examples like HSBC, Grant Thornton, IBM, JPMorgan. Aside from very large organizations and requirements, for most companies, the long-term lease will never make sense again. Lease terms have been shrinking for years in major markets around the world, but now there’s likely no going back. Recent transaction information from CBRE indicates that average lease terms have decreased by two years and one month over the past three years, in key cities such as New York, Chicago, and Toronto. 

Since the pandemic started, CBRE has also been actively engaged with a wide cross section of companies to find out how important more flexible lease terms will be. In June 2020, 73% of the respondents polled said flex office will play “some kind of role” while 23% said a “significant role”. By September, the percentages went up from 73% to 86% and 23% to 36%.

CBRE Canada also made mention of a potential reduction in demand, by as much as 10% in our recent Canadian Market Outlook. Using Toronto as an example, we illustrated what the impact on vacancy would be if we assumed a reduction of 10% in total demand because of on-going distributed work behaviors. The result was a potential increase of 400 bps in the vacancy rate. The question will become, is this structural vacancy (i.e., it never rebounds) or is it impermanent? No one knows for sure, but there is some smart money betting on a permanent reduction to demand.

Either way, I can’t see any downsides for landlords to assume this is true and start to plan how they can make their buildings “stickier” for the end-users. And, as any reduction in demand won’t be linear, some buildings could literally become obsolete without a major overhaul (others, of course, should be repurposed regardless). Anecdotally, I also haven’t spoken to a single customer who isn’t talking about downsizing and reimagining their office footprint.

Will the new ways of working decrease demand for office space?Those landlords and companies who acknowledge that change is not an option, stand to prosper. 

Where before Covid there was some plausible deniability from the industry, now there is no getting around the fact, that what a growing segment of the market (both big and small companies) wants: lease flexibility and the “outsourcing” of the workplace - is not (largely) what’s on offer. The “murky” part though, is establishing sustainable ways for landlords to offer more flexibility and service themselves, or partner with operators to facilitate what the customer wants at scale. Not to mention, the need for more modern and agile tools for managing lease contracts, when the frequency of changes increases and the lease units become smaller in size but increased in numbers.

The good news is that, despite turbulence in this sector, the tide really seems to be turning. This is especially evident in big announcements like CBRE’s investment in Industrious. This move validates what all the brokerage firms have been predicting for years, the massive growth of the flex office sector.

While the need for an anchor, long-term tenancy isn’t going anywhere, increasingly the market will migrate to shorter leases that offer flexibility and service in every sense of the word. The future of the office will undoubtedly be flexible/serviced for a very significant portion of the market, one that can’t currently buy in the way that they want most often.  

For context regarding this emerging asset type, in 2019, 50% of new office leases in the 50 largest markets were signed by flexible operators (not by traditional tenants). Source CBRE, JLL, Green Street Advisors

Dave Cairns

This blog is an edited version of a longer article, originally posted on April 22, 2021 by Dave Cairns on LinkedIn. Read the full article "What is the cure to the workplace pandemic?" here.

Disclaimer: This blog entry reflects my own ideas and does not necessarily represent the positions, strategies, or opinions of any current or past employer.

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Dave Cairns

Written by Dave Cairns

Dave is a commercial real estate content creator and an avid "futurist" when it comes to the office market, who can be found on LinkedIn talking about the importance of flexible working and Space As A Service. As his dayjob, Dave works for CBRE Canada as SVP Office Leasing, and he is a founder of CBRE Forward, where he helps enterprises, scale-up companies and landlords create dynamic office environments.