Post-Vaccine Demand for Office Space is Subsiding

New demand for office space fell for the second consecutive month in October to its lowest rate since the first quarter of 2021 suggesting that the initial post-vaccine surge of demand for office space has run its course. 

Down 30% nationally since peaking August 2021, all seven markets analyzed by the VTS Office Demand Index (VODI) saw declining demand for office space over the two-month period.

Even before the emergence of the Omicron variant, it was clear that the office recovery had started to falter in the face of the ongoing recovery. 

Occupancy fell by 2 million square feet as of November, compared to the third quarter in 2021, bringing the total loss in office occupancy to 133 million square feet, according to the National Association of Realtors. 

This was despite an increase in occupancy of six million square feet during the third quarter and a decline in work-at-homes from 35% of American laborers during the pandemic to 12% in October.

Seasonality-Defying Surge ‘Ran Out of Steam’

The VODI tracks unique new tenant tour requirements, both in-person and virtual, of office properties in core US markets, and is an early indicator of upcoming office leasing activity.

New demand for office space increased dramatically since bottoming out in June 2020, rising 444% by August 2021 before the prolonged, seasonality-defying surge ran out of steam. Since peaking in August, demand for office space fell 15 points in September and 11 in October. 

It is believed that the large ramp-up was due to pent-up demand—a surge of employers getting off the sidelines and into the market once sentiment brightened in light of the COVID-19 vaccine, VTS reported. The recent decline in new demand for office space suggests that the initial wave of pent-up demand has already materialized.

Most Cities See Office Demand Fall By 24%

While all core markets experienced a downturn in new demand in October, several markets, including Los Angeles, San Francisco, Boston and Seattle, experienced declines in excess of 24%. Seattle saw the greatest decline, down 31% from September to October. Seattle, however, is historically a very volatile market that tends to experience big swings in new office demand.

Some brokers in these markets, though, point to reasons for optimism. Nick Slonek, principal and managing director, Avison Young – San Francisco, tells GlobeSt that San Francisco has several large lease transactions pending. “Avison Young’s San Francisco office is involved with a few of these significant leases which are anticipated to close in the first half of 2022. Once some of these larger transactions consummate, we will see others follow suit which will be a very healthy stimulus for the region.”

Three markets, New York, Chicago and Washington, D.C., saw new demand fall by 10% or less in October, with Washington, D.C., seeing its fifth consecutive month of declines. In the two years leading up to the pandemic, both New York and Washington, D.C. saw meaningful growth in demand in October, distinct from October 2021.

Too Early to Predict Long-Term Effects

Despite this disconcerting new trend, Kelly Mangold, principal, RCLCO Real Estate Consulting, tells GlobeSt. that it is too early to predict the long-term effects of Covid-19 on the office market as a whole, as the pandemic has had different impacts regionally.

“In certain areas of the country, restrictive shutdowns and mask-mandates have caused many employers to embrace remote-work either temporarily or even permanently—with the hybrid-option of a combination of in-person and remote work as a popular third option. Other areas of the country have had office workers largely in-person throughout the past year and a half,” she noted.  

It is likely that in the next year or two many companies will reevaluate their office-space needs, perhaps looking at ‘hoteling’ or shared-desk work spaces, and prioritizing spaces for group meetings and collaboration over individual work spaces, for offices that adopt a more hybrid or flexible in-office policy, she said. 

Mangold added that the likely winners in the office market are still most likely going to be in the A+ urban and suburban locations, and mixed-use districts long-term, “though it remains to be seen at what level office demand will stabilize.”

Future-Proofing Office Space

In a way the softening demand for office space right now makes sense, Scott Harmon, CEO and Founder, Swivel, tells GlobeSt, as occupiers work out their own unique hybrid workplace strategies. As a result, landlords will need to step up and compete harder for a new wave of tenants bringing a new set of expectations for their office space, he says. 

“Those who do adapt, will continue to see their buildings leased up. Those who don’t, could be looking at extended vacancies. Smart property owners and teams are future-proofing their assets by making them more hybrid-ready. That means offices that are designed from the start to accommodate a mix of in-person and remote work—yes, even including in the metaverse—and that can be easily adapted as hybrid patterns and workforce needs evolve.”

Some Suburban Markets Still Shine

Another factor to consider in this story of softening office demand is the varying characteristics of urban versus suburban offices, Jeff Shaw, CEO of Atlanta-based Bridge Commercial Real Estate, the office operating platform for Bridge Investment Group, tells GlobeSt. He notes that major gateway markets have struggled due to COVID because of reliance on public transportation, office density, and other factors that created risk and delay in reoccupancy, whereas the story around suburban and secondary cities have been much different.

“It’s important not to ignore the bulk of office space across the country where companies have been able to reoccupy much more quickly and have had more success in figuring out how to best perform as a business during this recovery. This has translated into record levels of leasing activity in our portfolio.”

Shaw reports that in September and October of 2021, its office buildings saw a 20% increase in its suburban portfolio of inquiries and it closed 36% more in total square footage of leases. Additionally, there was an 18% increase in new deals and a 51% increase in renewal leasing compared to September and October of 2020.

“In September and October, we signed 42 leases in 2020 and 41 leases in 2021. Based on our overall lease activity, we are seeing much more strength in the suburbs as compared to urban gateway,” he said. 

More Than Half Changed ‘Return to Workplace’ Plans

Still, there is little doubt that some office landlords will be in trouble as these trends persist, if they are not already. “Very few office buildings went into default during the initial stages of COVID, as most large tenants continued to pay rent even if employees were not coming to the office. It is only when these large tenant leases expire that you see the net effect of COVID on office buildings,” Ann Hambly, founder and CEO of 1st Service Solutions, tells GlobeSt.

Hambly said that a fall Korn Ferry survey indicated that 54% of large employers have changed their “return to the workplace” plans, 20% of large employers said they didn’t expect to return until 2022, and 32% indicated that they would never.”

“I don’t think anyone really knows the full extent of the impact COVID has had on the office sector of commercial real estate, but one thing is certain—it is changing and that alone causes concern to owners,” Hambly said.