The Surprising Resilience of the Office Market

Commercial office space hasn’t played a starring role in the drama of the pandemic shutdown of 2020 — yet.

That could change, and the head of Trepp’s advisory services has offered some spoiler alerts as to what plot twists could be ahead for office.

COVID-19 caused shutdowns immediately slammed lodging and retail sectors, of course, and boosted warehouse and last mile distribution facilities, Lonnie Hendry said in his latest Trepp report on the office sector. But it’s a different story for urban high rise office buildings — which have stood largely empty since March, when home became the new work space. Still, those office owners have some historic advantages that may serve them well.

“Much has been written, with significant pontification about the death and demise of the office building,” Hendry said. “Before we bid farewell to the office market, we should be reminded that this property sector is resilient. It benefits from a few underlying fundamentals that give it strength during times of market disruption.”

For starters, Hendry noted, most office tenants have long-term leases in place. “It is not uncommon for an office lease to be 3, 5 or 10 years in length, with renewal options built in,” he said. “This buys the owner(s) time on the front end of any market disruption.”

Beyond that, office buildings are also “typically occupied by a wide array of tenants, each performing unique business functions in the marketplace,” he said. “This diversification becomes a hedge against any one sector, finance, technology, oil, etc. completely wiping out an entire office market.”

Of course, exceptions can be found, he said. Think Houston. Oil and gas tenants. So as the energy sector goes, so will their offices.

“Having credit-worthy tenants under long term leases help this sector maintain normalcy in the short term,” Hendry said. “However, its long-term prospects are predicated upon tenants choosing to honor their leases and continuing to pay their rent.”

Hendry offered a quick way to assess the impact COVID-19 is having on the health and longevity of office tenants. Look for subleases. If the sublease rate is going up, tenants are going out. For example, he noted that the San Francisco office market — dominated by technology companies — has seen a 33% increase in available sublease space from March to June. “In addition to having the highest office occupancy, San Francisco also has the highest weighted average revenue per square foot,” he said.

One pre-COVID development likely to work against office space owners is the recent fashion of the open office concept that has dominated the market for the past five years or more. That will create additional challenges with social distancing guidelines, Hendry said. Once perfect plans could be a problem.

“One of the interesting things to consider during this pandemic is that many tenants have not had any measurable use of the physical space they occupy,” Hendry said. “Employees by and large have been working from home. Thousands of workers are unsure if, or when, they will return to the office. The intrinsic advantages previously discussed become less and less impactful as this pandemic continues to linger.”

Clearly the end of the 2020 story is not yet written for office. But Hendry’s forecast suggests drama is expected.