Six months into the COVID-19 pandemic, there is mounting evidence that the knowledge workplace, traditionally housed in commercial office buildings, will emerge from the social and economic crisis permanently altered. At the beginning of the spring, as cities locked down and buildings closed, there were already indications that large-scale remote work would continue even after offices reopened, putting structural downward pressure on demand for commercial office space. For example, a Gartner survey of CFOs released in early April suggested that nearly three quarters of them would transition at least some employees to remote work on a permanent basis. And in August, a special edition of KPMG’s CEO Outlook found that 69 percent will be downsizing office space and 73 percent believe working remotely has widened their potential talent pool.
Also in August, the analyst group Mizuho Securities published a research note stating that “the work from home genie is out of the bottle.” The firm expects this to have permanent “negative ramifications for demand for pricey office real estate in central business district markets.” Though the note acknowledges recent counterexamples like AIG and Raymond James taking on large new leases in Manhattan, the firm nevertheless expects a disproportionate impact in “CBD markets like NYC, San Francisco and Boston.”
What might this mean for commercial office in the long term? One possibility is that remote work will ultimately prove overrated and that, once the virus is contained, things will return more or less to normal. At the other extreme is the possibility that remote work will prove so successful that home offices alone will fill the vacuum of space created by tenants who no longer need nearly as much commercial office space.
A third possibility is higher demand for smaller, more flexible, more purpose-built workplaces in secondary and suburban markets. This report examines this third possible outcome. In it, we evaluate leading indicators of the rise of the suburbs and offer insight to commercial real estate owners thinking about adjusting their portfolios to serve the future workplace.
The analysis that follows examines:
The Softening Urban Core Evidence from commercial leasing activity that suggests a shift may already be underway
The Residential Flight from Density Trends in housing sales and rentals that indicate a reshuffled distribution of office-using workers
The Future Workplace Model An overview of expert and worker opinion on an envisioned workplace arrangement that accommodates working from home but also includes a centralized headquarters–and possibly other locations as well
The Path to Value One approach to using data to inform commercial real estate portfolio strategy
As is typical during any recession, office leasing activity has been slow since the beginning of the COVID-19 pandemic. This is compounded by the classic recessionary pattern exhibited by both landlords and occupiers: kicking the can down the road. As CBRE puts it, “As their current leases expire, many occupiers are choosing short-term renewals due to economic uncertainty.” Landlords are eager to accommodate, especially at stable rents that tenants are able to pay in part due to government stimulus.
As noted above, the nature of this particular recession has generated a great deal of speculation about the long-term future of commercial offices, including its particular impact on major urban centers. The relative dearth of data poses a challenge in analyzing such theories. Subleasing, however (which is another behavior common in economic downturns), provides directional insight on the relative strength of urban versus suburban submarkets.
To test the hypothesis that urban office submarkets are already showing signs of weakness relative to suburban ones, Propmodo analyzed office listing data provided by RealMassive. The parameters were as follows:
The data set included listings from a range of market types:
New York and San Francisco are high-profile cities with concentrated residential and office markets
Atlanta and Dallas-Ft. Worth are two geographically large metro areas that are not transit-oriented
Nashville and Raleigh-Durham are two secondary markets that had been growing rapidly before the pandemic
For pre- and post-pandemic comparison, RealMassive provided active listings as of January 1, 2020 and August 20, 2020.
Each listing was denoted as either a direct lease or a sublease.
Property ZIP codes enabled assignment of listings to areas inside or outside the urban core of each market.
If the number of sublease listings increased disproportionately in the urban core from January to August, it means that relatively more occupiers are looking to offload space there. This could be an early indication that demand for downtown office space is already softer compared to space in the suburbs.
The findings of this analysis show clear evidence that the urban cores of some markets are set for higher vacancy and lower rents. The number of sublease listings has increased most dramatically in New York, especially in Manhattan. (See Figure 1.) San Francisco’s increase is modest by comparison, but it is nearly twice as high in the urban core–49 percent versus 27 percent.
Interestingly, Atlanta and Nashville have seen a similarly distributed spate of new sublease listings. In Dallas-Ft. Worth and Raleigh-Durham, however, sublease listings have increased more in areas outside the urban core. Not all markets appear to be reacting to the recession in the same way.
The results for New York and San Francisco are also consistent with data on the Toronto market published by Avison Young. Downtown Toronto represents approximately 42 percent of the total stock of office space in the greater metro area, yet it accounts for 63 percent of new sublease listings and a whopping 83 percent of sublease space listed since March 31.
Furthermore, only about 15 percent of sublease listings have actually transacted since the end of the first quarter, and the downtown submarket accounts for less than half (48 percent) of them. This despite accounting for nearly two thirds (63 percent, as above) of the listings.
While not conclusive proof of any long-term trend away from downtown offices, sublease listing data does suggest a current relative weakness in the urban core as compared to the suburbs in many markets.
The Residential Flight From Density
In responses to anecdotal reports of homeowners abandoning urban areas for lower-density suburbs, the residential listing and valuation platform Zillow published its “2020 Urban-Suburban Market Report” on August 12. Among its findings:
“[B]y and large, the data show that suburban housing markets have not strengthened at a disproportionately rapid pace compared to urban markets.”
“[I]n all but a few cases, suburban markets and urban markets have seen similar changes in activity in recent months: about the same share of homes selling above their list price, similar changes in the typical time homes spend on the market before an offer is accepted, and recent improvements in newly pending sales have been about the same across each region type.”
“For-sale suburban homes attract more than three times as much of Zillow’s traffic as urban listings do, but that was the case last year as well [emphasis added].”
From the macro perspective, then, there is no evidence of a mass migration of homeowners from urban centers to the suburbs. But homeowners are not everyone, and home ownership is already concentrated in suburban areas. The prevalence of renting in city centers is a crucial part of the picture.
Here there is evidence that some cities, in particular, are more primed for suburban flight than others. In the same report, Zillow found that “Rents in urban ZIP codes fell more relative to their pre-pandemic trend than in suburban areas, supporting the theory that urban ZIPs were disproportionately affected in the rental market.” CoStar’s “State of the Apartment Market” report for August corroborates this, reporting rising rents and falling availability for suburban apartments, with apartments in urban centers showing the opposite trend.
Altucher’s piece is full of anecdotes about New York’s unique vulnerability to the conditions created by the COVID-19 pandemic, including observations about acquaintances moving out of town and the danger that presents given the city’s fiscal reliance on property tax revenue.
A few days later, former State Department official Peter Van Buren picked up on this theme in The American Conservative. Refining Altucher’s case, Van Buren zeroed in on the exodus of a particular class of residents:
While overall only five percent of residents left as of May, in the city’s very wealthiest blocks residential population decreased by 40 percent or more. The higher-earning a neighborhood is, the more likely it is to have emptied out. Even the amount of trash collected in wealthy neighborhoods has dropped, a tell-tale sign no one is home. A real estate agent told me she estimates about a third of the apartments even in my mid-range 300 unit building are empty.
The importance of these articles lies in the implications for a very small number of urban areas that have a very large economic and social impact. New York and San Francisco have unusually high concentrations of wealthy residents. As early as April 2, there were signs that many of these were inclined to leave these high-tax, high-cost-of-living cities. With the progression of the pandemic, these uniquely dense cities appear to be exceptions to the overall national urban-suburban equilibrium identified by Zillow.
The median asking price of $1,499,000 was the lowest since 2014
Median time on the market was 144 days, a 68-days year-over-year increase
Figure 3 summarizes the data indicating declining residential sales and rental prices in Manhattan as of July 2020.
The data on apartment vacancy, rental rates, and home inventory in San Francisco paints a similar picture to that in New York. According to RealPage, an accounting and operations software company in the multifamily industry, vacancy in May reached 6.2 percent, up 2.3 percent from February. Additionally, the listing platform Zumper reported a 9.2 percent year-over-year decline in median rent for the same month.
Zillow’s data on home inventory reveals a stark difference between San Francisco and other cities. As of mid-July, the number of homes listed for sale in San Francisco’s urban core was nearly double (+96 percent) that of a year ago, implying an impending resident exodus, not to mention downward pricing pressure. (See Figure 4.) By contrast, home inventories remained near or below 2019 levels in most other cities tracked–though there does appear to be a rising trend in several other urban core areas.
It is worth noting that these figures suggest that the recent nationwide trend of rising home values has more to do with lower supply than with increased demand. When shelter-in-place orders went into effect, listing activity cratered across the country; in most cases, it has yet to recover fully. When it does, it is an open question whether demand will be strong enough to support current values.
The Future Workplace Model
There is an increasing wave of expert analysis and occupier opinion in support of a fundamentally altered workplace model.
It will hybridize with the home
As the pandemic has lingered into the late summer, more and more high-profile occupiers have taken concrete measures to make working from home a reality in the long term. Not surprisingly, the technology sector led the way. Twitter CEO Jack Dorsey made headlines in May by announcing that most employees could choose to work from home in perpetuity. Slack did the same in June. In late July, Google parent company Alphabet announced that working from home would be the norm for at least the next year, and Facebook followed suit a few days later. (The Wall Street Journal points out that this timing is not a coincidence, as it signals to employees that they can sign one-year leases outside of high-priced San Francisco–more on this below.)
Change in YoY Inventory from February 2020, in MSA and city proper (Source: Zillow)
In recent weeks, even some more traditional occupiers have signaled their commitment to expand remote work opportunities for their employees. Most strikingly, JPMorgan, the leading name in the banking and finance industry, announced in August that many of its more than 60,000 employees will maintain the ability to “cycle” between at-home and in-office work locations. Ford Motor Company, another old-guard industry leader, is preparing for “a future in which many, if not most, employees won’t come into the office every day.” Clearly, then, there is substance to early claims that the future of work would include far more working from home.
It will offer more choice to employees
In August, Spacemade, a London-based flexible office provider surveyed 350 office workers, 43 percent of whom said they “would like to spend at least some time in a local office.” This local office would ideally represent just one of several potential workplaces for respondents. “The most popular option was spending 2-3 days in a local office and two to three days in a central HQ every week,” the company said. “Participants from medium-sized businesses (50-249 employees) were the keenest on local working.”
It will be distributed
Industry observers and insiders alike now theorize that occupiers will shrink their downtown headquarters (even if they do not eliminate them) in favor of a distributed network of workplaces to complement home offices. Writing in the Harvard Business Review in August, the architecture and design group HLW called for an intentional rethinking of workplaces: “A more distributed model throughout cities and geographic regions, we believe, would better support employee performance and organizational resiliency while contributing to the improvement of the urban landscape and local communities.”
CBRE outlined exactly this “hub-and-spoke” model in a mid-year market outlook report released in July. Based on feedback from its extensive client base, the firm concluded that “In some markets—especially those in mass transit-dependent urban areas—companies are considering satellite or suburban locations to provide convenience. (See figure).”
The Changing Face of Work (Source: CBRE)
There is at least conceptual support for this model among occupiers as well. Workspace innovation firm The Instant Group recently launched an Agile CRE Think-tank, composed of 60 senior global CRE executives. A July article in Forbes summarized the group’s work and emerging vision: “WFH and core offices will be linked by work near home (WNH) situations. The result will be flexible spaces providing an office setting outside the home, yet boasting a location nearer where workers live.”
These “WNH office spokes” would support collaborative work while reducing or eliminating the need to commute to a central office “hub.” The Instant Group estimates that companies could ultimately save 5-6 percent on total costs by adapting space to a mix of core and flexible office space.
All this suggests a changing mindset about the corporate workplace. It could be the beginning of a new way of thinking about workplace locations. Instead of knowledge workers accommodating their residence to a centralized workplace, the reverse could soon occur: Employers may start to target workplace locations to the places where people live.
Retail property owners have long approached location strategy by targeting the areas that people want and need to be in order to live their lives. This mindset dominates healthcare real estate as well. It may be time for commercial office owners to think of knowledge workers more as consumers of office space than as captives of their employers. To do this, they will need to place their bets in a proactive, but disciplined way. The final section addresses one possible data-based path to doing so.
The Path to Value
A Hypothetical Example
If corporate occupiers adapt to multiple smaller, more flexible workplaces closer to their employees’ residences, then both they and commercial office building investors will need a solid understanding of where people will live and be active. Furthermore, this is likely to be a moving target, as people’s own determinations of where to live could depend less and less on prospects for commuting to a central workplace.
Data on the movement of people en masse offers a glimpse into how they might approach the task. Unacast is a software company that provides insight into personal mobility using data from individuals’ mobile devices. Its platform quantifies and illustrates the drastic change in mobility brought about by the pandemic in several ways that are of interest to commercial real estate professionals.
As a hypothetical example, consider the case of a real estate investor looking at the future of the New York City metro area.
Population Movement (Source: Unacast)
Using a combination of mobility data and mathematical algorithms, Unacast can identify people who have permanently (or semi-permanently) relocated. In the case of New York, pandemic-related migration patterns are illuminating. As the map shows, nearly half (approximately 46 percent) of people moving out of New York City have moved somewhere else in either New York (28 percent) or New Jersey (17 percent). They may have left the city, but many have not left the area.
County-level information provides more detailed insight. Two of the top three destinations for departing New Yorkers are Bergen and Hudson Counties in New Jersey, located just across the Hudson river from Manhattan.
There are, of course, many other destinations as well, including a sizable number of people who have relocated as far as California and Florida. But most have stayed nearby, which has implications for areas of the New York metro area outside Manhattan. The question is, what are they doing now, and where are they doing it?
Unacast’s Recovery Index takes mobility data down to the census block group (CBG) level. By analyzing the change in foot traffic within each CBG, Unacast determines whether or not personal mobility has “recovered” in that CBG compared to the pre-pandemic baseline. This data can then be overlaid on a map for a visual representation. The figure below shows the map for West Midtown, Manhattan as of September 5, 2020.
Foot Traffic in West Midtown NYC vs. Pre-pandemic (Source: Unacast)
Foot Traffic in West Midtown NYC: Time Trend (Source: Unacast)
The consistent red shading indicates that, consistent with many news reports, foot traffic in this area has not yet recovered to pre-lockdown levels. The dramatic change is visible above.
This contrasts with the towns of Teaneck (in Bergen County) and Kearny (in Hudson County), New Jersey. The next maps and graphs show that parts of both towns have begun to recover “normal” levels of foot traffic.
Foot Traffic in Teaneck, NJ vs. Pre-pandemic (Source: Unacast)
Foot Traffic in Teaneck, NJ: Time Trend (Source: Unacast)
Foot Traffic in Kearny, NJ vs. Pre-pandemic (Source: Unacast)
Foot Traffic in Kearny, NJ: Time Trend (Source: Unacast)
This information on personal movement can be a crucial component because it reveals the specific areas where people either want or need to be out and about to conduct their daily lives, even in the midst of widespread government restrictions on movement and gathering. To the extent that people wish to return to offices, it stands to reason that they will prefer to do so in locations that are also convenient to them for other reasons. While there are many data points that a corporate occupier or real estate investor would ultimately consider in making an investment decision on the scale of where to locate an office, this could be an important early indicator of where to dig further.
In this example, it is important to consider that Teaneck and Kearny can only be considered “suburbs” in the context of New York City. In most places, they would appear highly urbanized. The point is not that “suburbs” per se are or will be on the rise, but rather that certain micro locations may turn out to hold broad appeal to knowledge workers–and offer value to savvy investors.
What does this perceptual and empirical information tell us about the future of office buildings in both urban centers and suburban areas? And how should building investors and occupiers respond? Though the picture remains cloudy, a few conclusions are reasonable:
Demand for office space is especially weak in major urban centers
None of the data presented above proves the death of downtown as a centralized location for knowledge work. However, major urban areas–and particularly large coastal cities–do appear to be absorbing the brunt of real estate’s share of this recession. At minimum, there are warning signs that the eventual recovery will not be commensurate with the damage. But it is worth noting that weak demand for office space in the urban core does not necessarily mean a corresponding strengthening will occur in the suburbs.
Not all cities are created equal
The above analysis presents plenty of evidence that New York and San Francisco are different from other cities. By virtue of their size, wealth, and economic and cultural impact, they generate much commentary and drive many trends. And because of their concentration of commercial office space, they are feeling the effects of the COVID-19 recession especially acutely. But what is happening there due to the COVID-19 recession does not yet appear to be transferring to other cities.
The distributed workplace model remains theoretical
There are strong indicators from industry leaders and day-to-day office workers that something akin to the “hub-and-spoke” model is desirable; however, it remains to be seen how effectively building owners and occupiers will execute it. Even those companies that have announced plans to incorporate more working from home have not been as specific about their future real estate footprints. At this point, there are few, if any, models to follow.
Structural change in commercial real estate takes time
In the midyear outlook report mentioned above, CBRE noted that “The process of portfolio rebalancing will take at least three years before occupiers achieve an equilibrium that satisfies lower density for social distancing and higher levels of remote working.” There are several reasons to expect any change of this magnitude to happen slowly. One is the lingering direct impact of the COVID-19 pandemic. Until more knowledge workers are able to return to centralized offices, it will be uncertain how willing they are to do so. There is also the long-term nature of commercial office leases, which will moderate disruptions to tenant location strategy. Finally, occupiers themselves have a lot of work to do to figure out how to execute a distributed workplace model. This will be further complicated by the prospect of managing the leases or purchases.
Data is key to a proactive strategy
Bringing targeted, flexible workplaces to the locations people already want and need to be will be a tremendous challenge for commercial building owners and operators. Those wishing to pursue this strategy will need to manage risk by making informed, data-backed decisions.
That the post-COVID workplace will be different is a growing certainty. While it remains to be seen just how different, it is a good bet that working regularly in two or even three different locations will become the norm for many knowledge workers. For commercial office owners, success may well depend on meeting occupiers’ needs with a flexible network of the right space in the right place. If so, suburban and secondary markets will play a crucial role.