Office Developers Signaling Market Upside – Real Estate & Construction

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Then how is the question “what is the future of the office building?” still in the minds of everyone who owns or develops office space, it became clear that the last return to the office has our Allen Matkins / UCLA Anderson Forecast California Commercial Real Estate Survey panelists become less pessimistic. Although the mood in the office sector remains negative in the latest review, it is getting weaker and it looks like the sector has bottomed out and is poised for a possible rally. The current lull in office construction may be short-lived as demand for office refurbishments, low-rise office buildings and increased employment will rise in the coming year. The review reflects the fact that developers are less expectant, providing an early signal of a reversal in the market. When workers return to the office, demand for an office rich in amenities should push construction activity higher than sentiment indicates.

Office market leaders, Kevin ShannonNewmark and Liz Wilgenburg Allen Matkins, discuss what this sector of the California commercial real estate market will face.

1. Although the mood on the office real estate market is relatively more positive than in the previous two surveys, most developers and investors are still holding on to a wait and see attitude. How long will it last and what factors will change it?

Shannon: While the outlook for the office continues to improve, there is still more uncertainty in the office sector at the national level compared to other sectors such as industry, the multi-family Sun Belt, life sciences, etc. Research indicates that these popular sectors where the post-COVID data points are clear and more beneficial. Investment capital does not like uncertainty, and so many institutional investors have stayed away from the office product to see how work income will develop in the second half of the year if the proposal does not have strong WALT and credit. There is evidence that the leasing markets have bottomed out and are clearly beginning to recover.

Some investors, though, are now optimistic about the office and want to be the first movers before everyone else comes back. Investors are increasingly considering rotating to offices as yields in more popular sectors continue to shrink to record lows as a result of the huge capital weight in these spaces. Many of these early adopters hoped for some unfortunate office opportunity, but they never materialized. Pioneers believe that their acquisitions will now be more compelling than those that hit the market next year.

Uncertainties surrounding office earnings will disappear as companies return their employees to the office in the second half of this year. Only then will tenants understand which work model they prefer, hybrid or full, which will allow them to stop abandoning garbage and make appropriate placement decisions. I believe that next year, both owners and investors will know how this work on internal tension will play out, which will increase the transparency of market conditions. This will lead to an increase in the number of sales transactions by narrowing the gap between buyers and buyers, which is created in many markets due to the current difference in the expectations of owners and buyers. Currently, this gap between prices and offers is especially large for value-added offices.

Currently, there are office markets that are confronting these national trends described above. Bellevue, Washington; Burbank, California; and Sorrento Mesa / UTC, Caliornia, for example, are now worth better than before COVID. Each of these submarkets has key market drivers, such as big technology, life science or content creation, that have allowed them to thrive in the aftermath of the pandemic. Land in Bellevue for the construction of a dedicated office is in ruin and very competitive for bidders, for example.

Wilgenburg: At the moment, it seems that the developers are taking a “wait and see” approach, but are not really seriously thinking about postponing their development projects. The factors that will contribute to the end of this wait-and-see period are mainly the persistence of debt, the interest of the tenants and, consequently, whether the rental rates will support construction costs. Right now, many tenants are moving out of their “wait and see” periods when they entered short-term renewals in 2020 while they reevaluate their current space needs. These short term updates are likely to end around 2023-2024. Meanwhile, other office tenants looking for permanent solutions now face stiff competition for affordable first-generation building space with amenities, wellness benefits and ease of connectivity, while competing with major expansion from life science tenants. The result of all this competition is very good rental rates in these projects, which seem to be getting higher and higher. Therefore, I predict that many developers will see these rates and stop working on their projects to fill projected vacancies in 2023-2024. Meanwhile, developers who have not adhered to a wait-and-see strategy or are only a few months late will benefit from the current competitive market for top-notch development projects in hot markets.

2. Two scenarios are predicted: 1. Less office space will be required, while part of the staff will constantly work remotely; and 2. more space will be needed to accommodate new health and safety guidelines. What’s your prediction and why?


Shannon:
I predict most workers will return to the office in the fall. Many companies will adapt hybrid models first, and many will insist that workers return full time. Employees in the office will have a clear competitive advantage that will force many remote employees to return to the office over time, especially ahead of the Christmas bonus season. The reality is that most CFOs at companies want their employees to return to the office, even if they publicly declare that they will be flexible about their scheduling. During the pandemic, there was no shortage of competition because everyone worked from home. This changes especially after Labor Day.

I predict that most companies will not need less office space, and that many companies will begin to allocate more space per employee and reverse the trend of space reductions per employee that has occurred over the past decade. I do not know of a single company that, due to the recently adopted hybrid operating model, would say that the offices will be divided. Employees still need their own office, even if they only plan to be there three or four times a week. Initially there will definitely be fewer hot table concepts and more space per employee, although this may change over the years as we move away from this pandemic. After the tragedy of September 11, no one wanted to rent the upper floors of multi-storey buildings, but over time, the situation has changed.

Wilgenburg: For the foreseeable future, it seems likely that typical high-rise office buildings will have fewer field workers each day than before the pandemic, due to hybrid operating models. For many companies in mainstream markets, this will ultimately lead to reduced space requirements. However, for tech tenants who previously worked at extremely high density, it seems that these companies are now planning to convert individual cabinets into flexible or collaborative spaces that will not dramatically reduce space, and, in fact, in many cases , led to the fact that technical tenants began to look for more space. In addition, many tenants want to enter into longer leases, which will increase the profitability of many buildings.

3. We did not see a massive exodus from large cities as originally predicted at the start of the pandemic, but there has been significant relocation to less dense communities. How will this affect the development of the office in terms of location and design in the future?


Shannon:
Large global innovation cities such as Los Angeles, San Francisco, New York and Seattle will continue to be popular for investment capital because of the abundance of skilled talent and their inherent social benefits. Many employees had no reason to live in the big cities during the long ban, but the latest data makes it clear that employees are flocking back to those metro stations, waiting to be returned to the office. Tenants during the pandemic were looking for flexible placement solutions, which often consisted of shorter-term lease extensions until there was more clarity about space requirements. Several companies have explored spoked and hub models with small back offices located closer to employees’ homes to reduce travel time. Joint operations will also be used more frequently by companies in the aftermath of the pandemic to provide greater employee flexibility.

The development of the new spec office will continue to take place primarily in submarkets with strong growth engines such as large technology, content creation and life sciences. For example, Bellevue, Washington, had the fastest land sales since COVID for office development on the West Coast. He also saw companies like Amazon, Microsoft and Facebook demolish millions of feet of new office space during the pandemic, so building a new office is justified and justified.

Wilgenburg: The pandemic did not change the design of most new greenfield buildings, but accelerated certain design trends that already existed. Buildings have already moved to areas with enhanced outdoor amenities and focused on sustainability, technology and wellbeing. All of these factors are now considered important for tenants looking for new space. Developers who have established LEED, WELL, Advanced Air Filtration Systems and Contactless Control in their future development projects have a great competitive advantage over existing space and are now highlighting these advantages more prominently in their marketing materials than in pre-pandemic conditions. Peace.

The pandemic, however, could change the desired location of many development projects from dense urban centers that relied on public transport to low-rise projects with light traffic in suburban areas, but I am skeptical about the certainty of this kind of prediction. It seems clear that many people are not interested in long commutes from the suburbs to urban areas. This means that as long as there is not enough housing in our city centers, office buildings located next to residential buildings will be more attractive. However, this concern is undermined by recent data that rental prices in densely populated urban areas are starting to rise as people return from temporary housing options in the wake of the pandemic. This is good news for San Francisco’s development and probably not a problem for Los Angeles, where low-rise housing was already popular and public transportation was less popular before the pandemic.

The content of this article is intended to provide general guidance on the subject. You should seek professional advice regarding your specific circumstances.

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