Is This Sluggish Office Demand Permanent?

New demand for office space in January was unchanged from December, remaining at 58 percent of its pre-pandemic level but up 75.8 percent year-over-year. 

This marks the fourth consecutive month of relative stability in the VTS Office Demand Index (VODI) since peaking in summer, and falling in the second half of 2021. 

The VODI tracks unique new tenant tour requirements, both in-person and virtual, of office properties in core US markets.

Nationally, new demand for office space grew 163.6 percent, peaking at 87 percent of normal, in the first eight months of 2021 before falling sharply and leveling off in the following months. Since October 2021 the VODI has hovered between 61 and 58 and is depressed relative to pre-pandemic levels, despite a healthy labor market. A VODI of 100 is a benchmark for pre-pandemic normal.

Hybrid Work Model Driving This

Analysts contacted by GlobeSt.com have varying reasons for the stall in leasing. 

For starters, though, it should be noted that news is not necessarily as grim as it might appear. Scott Homa, senior director, office research at JLL, says that leasing activity rose by 9.2% last quarter—marking four consecutive periods of quarterly gains—and that top-quality space remains in high demand.

“Just under 25% of recent leasing activity is taking place in new supply, which represents 12% of the total office market, underscoring tenants’ intense flight to quality,” he tells GlobeSt.com. “Tech remains the dominant leasing driver, representing 21% of quarterly activity. There’s been an increase in long-term leases, which is a harbinger of market confidence. Deals longer than 10 years are underlining growing momentum from major tenants: 45% of recent transactions (Q4 2021) are in the 10+ year segment.”

Also, some markets are doing better than others. “The overall demand for office space remains sluggish. However, the old adage ‘location, location, location’ remains true, as demand for Class A space in certain submarkets in South Florida remains strong, primarily with financial services firms from the Northeast,” Scott P. Andrew, special counsel at Duane Morris, tells GlobeSt.com. “Additionally, demand nationally appears to be strong in life sciences and high tech, especially in New England and Southern California.”

Even in beleaguered markets, such as Manhattan, there are still signs for optimism. “One key metric we are keeping an eye on is the amount of weekly foot traffic we are seeing,” Danny Mangru, NYC regional manager, Avison Young, tells GlobeSt.com. “We are seeing office usage down 60% from pre-covid levels, however, we have seen a four-week consecutive increase.”

Still, though, it is clear that leasing is not where the industry would like it to be. And it may never be, at least by pre-pandemic activity. 

Sarah McKevitt, real estate senior analyst with RSM US LLP, tells GlobeSt.com that the office demand is going to be slow to rebound, if not permanently changed, as a result of the pandemic. 

“The employee preference for a hybrid work model is driving this,” she said. “Employees want flexibility as a term of employment instead of as an option available after a few years of hard work.”

And while economic and job growth are positively impacting office demand, it’s no longer a one-for-one relationship because not all office jobs will be full time in offices, Joseph Rubin, Senior Advisor, EisnerAmper, tells GlobeSt.com.

“That ratio will depend on the market, as many are back at work while others will be remote or hybrid for the foreseeable future.”

Investment Specialist David Vincent at Cadre adds that many companies have not yet formalized their return-to-work policies, leaving many questions about how much and what type of office space those companies will need. “However, we continue to see a flight to quality as many companies upgrade their location and or amenities,” he tells GlobeSt.com.

Petra Durnin, head of market analytics at Raise Commercial Real Estate, though, points out that corporate plans are well underway.  “Some companies already had a great intentional workplace and need only open their doors to give employees a much-needed place to collaborate,” she tells GlobeSt.com. “Others need to reconfigure space, even expand or relocate to provide effective collaboration spaces as well as wellness features such as operational windows, natural light, indoor gardens, and outdoor spaces to center on the human experience.”

Seasonality Conditions in Play

Seasonality may be another reason for January’s lackluster performance, Eli Randel, Chief Strategy Officer, Crexi, tells GlobeSt.com “While demand in select major markets may appear flat from December to January, we largely attribute it to seasonality as companies put their budgets and year-end plans in motion. 

“We expect to see continued growth in both tenant and user acquisition demand as return to office plans commence in a hopeful return to relative normalcy. We generally believe demand will continue to grow throughout 2022. With limited development of new office product last cycle, we expect tight conditions.”

Covid Still A Factor 

Covid is still a factor for many companies, which have had to delay plans to return to the office numerous times as different variants arose. Hopefully, though, that impact is lessening. 

Andrew Ouvrier, partner, Cox, Castle & Nicholson, tells GlobeSt.com that COVID–19 will still have an impact on the office leasing market, “but we expect that impact to be more subdued in 2022 as landlords and tenants adapt to life with the virus and the general outlook on the ability to manage the effects of the virus continues to improve.

“While we anticipate increased leasing activity in all office leasing sectors, especially in the second half of 2022 when we anticipate there will be more employees who have returned to the office, we expect the greatest increase in leasing activity to be in newer Class A properties, flex space properties, and medical office properties.”

Overall, though, the industry can expect occupiers to take a hard look at their real estate this year, says Brian Haines, Chief Strategy Officer, FM:Systems. 

“They’re pressed to ensure work environments actually suit the needs of their employees, while also identifying potential cost-reduction opportunities,” he tells GlobeSt.com.