Some large employers are sacrificing square footage to accommodate remote work. This could have a devastating effect on building owners and towns.
As office vacancy rates reach their highest levels in decades as companies abandon physical locations in favor of remote jobs, the real estate industry in many American cities faces a potentially grave danger.
Businesses discovered that they could operate with virtually all of their employees absent from the office during the pandemic, an arrangement that many hope to continue in some form. This could devastate the large property corporations that construct and own office buildings — and result in a sharp slowdown in development, steep declines in office rentals, fewer people visiting restaurants and shops, and potentially perilous declines in city and school district tax revenue.
In less than a year, the market value of office buildings in Manhattan, which is home to the country’s two largest central business districts, has fallen by 25%, according to city figures released Wednesday, leading to a projected $1 billion loss in property tax revenue.
JPMorgan Chase, Ford Motor Company, Salesforce, and Target are all vacating expensive office space, while others are considering it. Jamie Dimon, CEO of JPMorgan Chase, the city’s largest private employer, wrote this week in a letter to shareholders that remote work would “significantly reduce our reliance on real estate.” According to him, his bank “can need seats for only 60 employees on average” for every 100 employees.
And, just as Coca-profits Cola’s would plummet if customers suddenly reduced their consumption of soda, owners of office buildings, many of which are owned by pension funds, insurance firms, individuals, and other investors, could be hit hard if many businesses reduced their room rental. “The pandemic has shown the viability of working from home,” said Jonathan Litt, chief investment officer of Land & Buildings, a real estate investment company that has taken a bearish stance on the New York office industry. “It is not going away; companies will adapt, and office real estate will bear the brunt of the adjustment.”
Across the country, the vacancy rate for office buildings in city centers has steadily increased over the last year to 16.4 percent, the highest level in nearly a decade, according to Cushman & Wakefield. This number could grow even higher, even as vaccines allow some people to return to work, if businesses continue to shed office space in favor of hybrid or entirely remote work.
So far, landlords such as Boston Properties and SL Green have avoided significant financial losses by extracting rent from tenants locked into long leases — the average contract for office space is around seven years.
However, when leases come up for renewal, property owners can find themselves with dozens of vacant floors. Simultaneously, several new office buildings are under construction nationwide — 124 million square feet, or enough space for approximately 700,000 jobs. These adjustments could result in a decrease in rents, which had reached new highs prior to the pandemic. Additionally, rentals contribute to the determination of assessments that serve as the foundation for property tax bills.
Numerous large employers have already notified the owners of many prominent buildings that they plan to vacate when their leases expire. United Airlines is vacating approximately 150,000 square feet, or more than 17% of its space, at Chicago’s Willis Tower, the country’s third tallest structure and a valued possession of Blackstone, the Wall Street company. Salesforce is subletting half of its space at 350 Mission Street, a Skidmore, Owings & Merrill-designed and Kilroy Realty-owned San Francisco tower.
Approximately 17.3 percent of Manhattan’s office space is available for sale, the largest percentage in at least three decades. According to a recent survey by the real estate services firm Newmark, asking rentals on the island have decreased to just over $74 per square foot, down from approximately $82 at the start of 2020. Elsewhere, like in Boston and Houston, asking rents have mostly remained stable year over year, but have increased marginally in Chicago.
Uniqlo, a Japanese apparel brand with its US headquarters in Manhattan’s SoHo neighborhood, recently moved to another office building nearby, creating an open layout with tables for its 130 employees who will only be in the office a few days a week. Many of its office staff will continue to operate remotely after the pandemic, while others, such as those in the marketing department, will hold meetings in SoHo on occasion.
“As a leader, it’s been difficult because face-to-face interaction is critical,” said Daisuke Tsukagoshi, CEO of Uniqlo USA. “However, as a Japanese company with a global footprint, the requirement for remote collaboration among multiple locations has always been ingrained in our culture.”
The stock prices of the large landlords, who are often organized as real estate investment trusts that distribute almost all of their profits to investors, are trading far below their previous peaks, despite the fact that the broad stock market and some companies in other sectors, such as airlines and hotels, which were hard hit by the pandemic, have reached new highs. Boston Properties, one of the largest office landlords, has lost 29% of its value since the pre-pandemic peak. SL Green, a significant New York landlord, is 26 percent less expensive.
According to Fitch Ratings, office landlords’ income would decline by 15% if companies permitted employees to work from home an average of one and a half days per week. Three days at home could result in a 30% reduction in income.
Senior executives at property firms claim that they are unconcerned. They predicted that working from home would rapidly decline until the majority of the country has been vaccinated. Their justifications for believing this? They claim that many corporate executives have informed them that it is difficult to motivate employees to cooperate or train young professionals while they are not physically present.
Additionally, these landlords argue that their properties — referred to in real estate parlance as “class A” buildings — would do better than more pedestrian offices, hotels, and retail properties. “We believe that differentiated office product, such as Willis Tower, will continue to attract high-quality tenants, and that buildings that have invested in facilities, utilities, and technology will be well-positioned going forward,” said Nadeem Meghji, Blackstone’s head of real estate for the Americas.
Additionally, landlords said that even though workers are not required to report to work every day, they would desire their own desks and cubicles that must be socially isolated.
Of course, several businesses are ready to reopen their doors. Several large technology firms, including Amazon, Facebook, Google, and Apple, expanded their offices in New York City during the pandemic, and others are considering expansions in other cities. Amazon announced last week that it would “return to an office-centric atmosphere as our baseline.”
“Companies that operate in person will continue to be more competitive than those that operate virtually,” Owen D. Thomas, CEO of Boston Properties, said in an interview.
The pandemic-induced recession is significantly different from previous ones, which may favor landlords. Banks, insurance companies, brokerage houses, and other similar businesses laid off about 600,000 workers after the financial crisis. However, businesses that employ a large number of office employees have escaped relatively unscathed. “The majority of our customers are doing well — they are not in a recession,” Mr. Thomas said.
Colin Connolly, CEO of Cousins Properties, an Atlanta-based office landlord, predicted that technology companies will retain the majority of their existing office space and grow in cities such as Austin and Atlanta. Cousins’ buildings are home to four of the world’s biggest technology firms.
“Our assessment is that they are not relocating to operate from home,” Mr. Connolly said.
However, the demand for space by technology firms might not be as great as it once was. Facebook and Cousins were in the process of negotiating a lease for 353,000 square feet in downtown Austin, but the Austin Business Journal announced in March that Facebook had withdrawn from the negotiations. The companies declined to comment on their discussions.
“We are committed to Austin, as shown by the fact that over 1,200 of our employees live here,” said Tracy Clayton, a Facebook spokesperson.
Predictions of a return to the workplace have often proven false. Many real estate executives predicted a year ago that state-imposed lockdowns will be lifted by the summer. After a year, several states have relaxed controls, and about three million Americans are now receiving vaccinations on a regular basis. Yet, on average, just a quarter of jobs in the ten largest urban areas have returned to work, a pace that has remained relatively stable for months, according to protection company Kastle Systems.
Kastle noted that cities with the lowest return rates are those on the coasts, such as New York, San Francisco, and Washington, where lengthy commutes, sometimes on dysfunctional public transportation, are popular. Moody’s predicted in March that office landlords with multiple properties in coastal cities will face the most financial strain in the coming years.
“We are simply going to continue bleeding lower for the next three to four years to ascertain the new level of tenant demand,” the investor said.