By Billy Byrne
Anyone reading this understands that 2020 was an incredibly volatile and challenging year, and the commercial real estate industry was one of the most affected by the COVID-19 pandemic. It proved to be an interesting dynamic in that not all commercial real estate segments were affected in the same way. The industrial sector of the economy has remained strong and vibrant, as have e-commerce-based companies. This has created unprecedented demand for industrial and manufacturing space around the country, and many categories of industrial space have actually seen vacancy rates decline and rental rates increase. Similarly, the biotech industry set capital formation records during the pandemic, creating unforeseen and unprecedented demand in all of the major biotech markets across the country.
This is where the decoupling begins. While user demand remains strong in both the industrial and biotech wet lab categories, the retail and office sectors of the commercial real estate market are being decimated in real time. Everyone knows firsthand about the carnage in the retail industry, as retail space has flooded the market due to the many restaurant and small business closures. Dense urban areas where tourists and the business community rarely patronize any longer have become particularly soft. There has been a flood of office sublease inventory hitting the market in most metropolitan areas, creating overnight competition with landlords at discounts from 20% to 30% below direct lease asking rates. Some tenants with leases expiring since the COVID-19 outbreak have not renewed and have simply relinquished their space. This phenomena of both the increase of sublease space and tenants giving up their space has caused office vacancy to increase dramatically. While some in our industry hypothesize that this effect will reverse later this year, we’re not so sure. In most markets during the Financial Crisis, it took three full years for rents to fall to their trough. Of course, there will be pockets that remain relatively stable, but we believe most markets will not recover for many years.
COVID-19 has resulted in millions of white-collar jobs being lost. In addition, the pandemic has caused companies to rethink their employees’ need to be in the office, and businesses of all sizes are currently exploring what their work from home policy is going to be post-COVID. Some companies we are collaborating with are embracing the work from home model, offering employees options to work from home part time or full time in the future. Depending on the company and industry, anywhere from 10% to 30% of employees will work remotely full-time or part-time post-COVID in the majority of companies surveyed. The result of this is that employers are going to need significantly less office space when they do return to the office.
What this inevitably means…and it’s already happening…is downsizing as each tenant has the opportunity to confront their lease expiration date. As much of corporate America downsizes and determines if they only need a fraction of their pre-COVID footprint, companies will generally be moving to appropriately smaller sized spaces. The collective result of tenants downsizing one at a time is what we call “negative net absorption,” whereby space floods the market on a net basis. Across-the-board, as commercial real estate tenants downsize their space requirements due to having less people, or having less people in the office, millions of square feet of office space will come back to the market. This will cause availability rates to increase and rent to decrease, likely for the next 2 to 3 years. A staggering 8,000,000 SF of space was vacated by office tenants in the last three quarters of 2020, causing vacancy to spike from 12.8% pre-pandemic to nearly 21% currently. The Central Business District experienced the largest impact due to massive consolidation and downsizing within the energy sector.
2020 was just a warm-up of things to come for the commercial real estate office sector. It is reasonable to assume that this trend will continue through 2021 and that availability rates in all metro markets will range from 20% to 30%. This downturn is not analogous to the Tech Wreck of 2000 or the Mortgage Crisis of 2008. Once we finally hit bottom, the bottom is likely to persist some time before an economic adjustment causes an increase in employment in order for office space demand to increase. For those in our industry that are saying it will never happen, the fact is that it has happened before, and we managed our way through it.
The good news is that the market has shifted from Landlord to Tenant-favorable for the first time in 13 years. Tenant concession package are becoming increasingly more generous and Landlords are aggressively competing for tenancy. Metro wide, large blocks of available space are abundant for the first time in recent memory and many more will come to market as tenants implement their revised long term real estate strategies.
The silver lining is that as companies continue to fight to recover, to maintain jobs and profitability, and to lean down expenses, the commercial real estate office market is going to offer opportunities that most of us have not seen in our careers, or in recent memory.
Billy Byrne is executive vice president at Hughes Marino, an award-winning commercial real estate company with offices across the nation. Contact Billy at 1-844-662-6635 or email@example.com to learn more.