The Office Market May Be Soft But Tenants Aren't Getting Extreme Deals

As the omicron variant continues to threaten a return to pre-COVID normalcy, many office tenants are questioning whether the market is continuing to soften. On the hunt for advantageous deals, occupiers are pondering renegotiating existing leases or reducing their footprint to remain competitive in a tight labor market. 

But while the market has slowly softened… extreme deals for occupiers are rare,”  says Kirsty Cameron of Savills in a new report. “The reason for this is while most office employees have worked from home throughout the pandemic, many companies continued to pay for their office space. Availability increased throughout the pandemic as occupiers who had leases up for renewal or chose to sublease their office space. For landlords to maintain financial and operational sustainability, their strategic response to the pandemic has been and continues to focus on increasing concession packages and deploying other occupier benefits before dropping rental rates.”

And compared to other economic crises, the “black swan” economic impact of the pandemic impacted CRE quickly. The uncertainty associated with openings, reopenings, and emerging variants has led to the market remaining steady, instead of greatly softening.

“Savills advisors noticed that traditional five or seven-year lease extensions shrank for many companies, down to a year or two,” says Cameron. “As the vaccine was released and became more widely available in mid-2021, there was an uptick in occupier confidence which provided hope to many landlords that companies and their employees would soon be re-entering the office space. Due to high office space availability and the emergence of the Delta variant, the softening of the market throughout the pandemic did not bounce back as landlords were hoping” by year’s end.

Despite that, however, Cameron says she’s observing “generous” concession packages from landlords, launched in a bid to retain tenants and strike back against high availability rates.

“There are numerous new and speculative developments that could allow for the market to continue its trend of high availability,” she says. “The combination of the high availability rates and concessions allows for the market to provide tenants leverage.”

Signs of new weakness in the sector began to resurface this fall, as news of the omicron variant hit US markets. New demand for office space fell for the second consecutive month in October to its lowest rate since the first quarter of 2021, according to the VTS Office Demand Index.  That’s a 30% decrease over its August 2021 peak.

Despite that, however, some experts say it’s too early to predict COVID’s long-term effects on the sector.

“In certain areas of the country, restrictive shutdowns and mask-mandates have caused many employers to embrace remote-work either temporarily or even permanently—with the hybrid-option of a combination of in-person and remote work as a popular third option,” said Kelly Mangold, principal, RCLCO Real Estate Consulting.  “Other areas of the country have had office workers largely in-person throughout the past year and a half.”

Mangold predicts that in the next year or two many companies will reevaluate their office-space needs, with an eye toward ‘hoteling’ or shared-desk work spaces.