Back to the office stagnated again, what would be the future of office buildings?

In April 2020, when the epidemic was at its peak, the average office occupancy in the U.S. was only 14%, and by the end of 2021, this number had gradually recovered to 40% (see figure 1). People might think that employees start to return to the office, and the performance of office properties might rebound. However, according to the Kastle office occupancy report, this figure shows no further development even in the post-covid era, even though the pandemic situation is stable, and the quarantine policy is relatively loose. Until 2022 September 7th, the back-to-work index still lingers at 40% for the ten biggest metropolitan areas in the U.S; Kastle System said this “half occupied” situation might become a "New Normal" for the office market nationwide.

This is undoubtedly a negative signal for office property investors looking forward to a recovery of the office market. Why does people’s office activity not recover to the level before the epidemic? What does this mean for the future of the office?

Figure 1: Return to work barometer


Source: Kastle office occupancy report from access system control data

The most crucial factor is that employees’ working modes have changed.
The working mode will undoubtedly have the most significant impact on office space demand. Although managers prefer their employees to return to the office because they think the office space helps improve communication efficiency, facilitates the connection between employees, and promotes working productivity. But employees don't think so. Firstly, they enjoy the convenience of remote working; they can flexibly arrange their own time and do whatever they want at home. Evidence shows that work-from-home would not impair their productivity but improve it. Second, returning to the office means they have to pay the expenses of "office working”, such as transportation, meals, other fees, etc. . Furthermore, returning to the office means they might need to reschedule their life, such as babysitting or caring for the pets and elderly members of the family. Due to the long-time working-from-home policy, not just the employees but also their family members' schedules have changed. Facing the back-to-work policy by the company, they are even willing to take a pay cut to keep the freedom brought by working from home.

Aware of this preference conflict between the company and employees, the manager worries that making tough decisions -- remote-only or in-person only -- will bring considerable risks to the company's future operation. Hence, they take a” buffer plan” instead to get the hesitant workers back to the office: hybrid work with minimum fixed attendance for a few days a week. Such as Alphabet, one of the top 10 Fortune 500 companies, requires their employees to attend the office three days a week from the first week of April 2022, but flexibility is still possible for those who need a longer time to back to the office.

These companies have signed long-term leasing contracts with the landlord. Due to the low attendance of employees and not fully occupied working spaces, many companies such as Netflix, Yahoo, and Verizon are subletting part of their office space in the market. Some aggressive companies even choose remote-only working modes, such as Yelp, which is closing its NY, Chicago, and DC offices. Lower demand for office space leads to a surplus supply and a high office property market vacancy rate. The stock of office space available for lease in Manhattan has even reached an astonishing 19.2%.

What should office property investors do?
In the post-epidemic era, employees have shown preferences for certain office buildings: they are more enthusiastic about the health and green attributes of the working space. According to the results of Essity Professional Hygiene’s survey of 2,000 U.S hybrid working employees, around half of them (51%) said they are more environmental-conscious after working from home, and around half of them (46%) said they are more aware of the greenness of the working place after the outbreak of the covid. This means managers of the company must make the working space more attractive to employees if they want them to return to the office! The property investor also needs to consider this new trend when managing their portfolio, especially when the supply in the office market is surplus and the company has many choices. The resilience of rents and occupancy of the green buildings compared with traditional buildings during the epidemic is powerful evidence of the economics of the prime office and people's "flew to quality" trend during turbulent times.

Converting the office into residential property might be a solution. For example, Silverstein Properties and Metro Loft saw the arbitrage opportunity given the office supply surplus and residential property supply deficit, so they recently decided to acquire a 30-story office building and convert it into an apartment building. But we need to keep in mind that not all office property is suitable for conversion into residential property due to land use policy or structure problems. The conversion usually is accompanied by the high cost and high uncertainty about the future return.

What can we expect from the office property?
Catering to the trend of new needs and preferences might be a good strategy, such as providing better office facilities and more healthy attributes, flexible and collaborative office space, or converting the usage of the office!

But we must be aware that it would be relatively complex for the office to have financial performance back to the level before the pandemic because people's working mode has changed in the foreseeable long-term future, and the contraction of office space demand is inevitable. This will not only negatively impact the future cash flow of office property but will subsequently bring challenges to refinancing and mortgage activity.