Pandemic Fallout Could Spur 'Broad Experimentation' in Office Leases

The fallout from the coronavirus pandemic could spark lasting changes to traditional offices, according to a DBRS Morningstar report, including a “fundamental rethinking” of the open office concept and an increase in office vacancies nationwide.

“Because there is unlikely to be one solution that works for every company, we expect to see broad experimentation with the way workplaces are organized,” the report said.

In the short-term, there will be less effect from work-from-home arrangements because many tenants are locked into relatively long-term leases.

In a sample of 366 loans that DBRS Morningstar selected, the average lease length remaining for the properties’ largest tenants is about four years and three months, 20 leases still have more than 10 years left and 52 leases will expire within the next year, the report said, noting there was still a risk that tenants could stop paying rent or not re-sign.

In the long term, if offices begin to adopt socially distant layouts, several scenarios could play out, some of which could be positive for office properties, the report said.

Under one scenario, some tenants, after reconfiguring their space to allow for social distancing, will maintain their existing footprint and allow some employees to work from home every day or on a rotating basis. This will not have a material effect on the office market until a significant number of leases begin to expire, the report said, adding companies may begin to reevaluate their office space needs once their lease expires.

But it remains to be seen whether landlords will be able to pass the costs associated with reconfiguring an office space along to tenants, the report said, as property owners may be incentivized to absorb these costs to attract and retain tenants.

Under another scenario, companies that view returning many employees into the office as too risky may reduce the number of employees in an office “to such a degree that would allow them to reduce their footprint,” the report said. It cited a CoreNet Global survey that showed 69% of corporate real estate professionals said their company will take up less real estate after spending time working from home.

The report cited Reis’ estimates, which projected that by the end of 2022, nationwide office vacancy will peak at approximately 20.2% and improve to 19.1% by the end of 2024. “The recession and trend toward leasing less office space could contribute to the nationwide increase in office vacancy that Reis is projecting,” the report said.

Another possibility, the report said, is that some companies may require all employees to work in the office and will lease more space to accommodate social distancing. “We believe this is less likely to occur because it would increase costs significantly,” which may not be prudent during the recession, the report said.

Overall, the report said that the coronavirus pandemic, through social distancing measures, could lead office tenants to stop shrinking, which would slow or reverse the drag on the office market. “But, if remote work and virtual meetings last beyond the pandemic and result in shrinking corporate footprints, an office market already reeling from an economic downturn could face a troublesome decreased demand for space,” it said.