Are there reasons to be optimistic about the commercial real estate market? As we know, the office market is undergoing a difficult period. Vacancies are up, rents are down, lenders are taking back properties. From afar this looks all like a terrible situation – or is it?
The declining demand for office square footage is nothing new.
It is a trend which began in the early nineties with the advent of personal computers. Large law firms restructured their need for space when entire law libraries fit on a couple disks, attorneys / professionals started typing and the need for secretarial support diminished.
Ernst and Young in the nineties realized that 75% of their staff were at one time or another on assignment at their client’s office and did not occupy their assigned offices on a permanent basis. They developed a system where only a few senior partners would have a permanent office. The accountants would “check in” an individual office for the day and free it up at the end of the day. This system enabled E&Y to reduce their footprint and rent expenses, much to the dismay of office property owners.
Xerox in the Silicon Valley in the eighties, was famous for letting their development teams work out of rented luxury houses, not office.
These are merely examples of how the office market has gotten broadsided before and yet, survived.
Today we have the “post pandemic” crisis, where workers and employers are experimenting with the “work at home” system, reducing demand for space.
This decrease in space demand is compounded by higher interest rates. $1,5 trillion of office debt is due in 2024/2025. This is scary. But scary for who? Mostly banks and institutional owners. Reduction in property values will also create a substantial local tax revenues shortfall.
The real estate market, especially the office market, is a perfect real-world lab of all the basic economics theories. Especially the basic laws of supply and demand. Price points adjust automatically and brutally within a matter of months, if not sooner.
So, what happens now?
Consider that:
There is no new office building construction.
Office buildings are converted to apartments, which command a higher per sf. price, reducing supply further.
Workers and employers are getting disillusioned by the work at home fad. Productivity is down, work quality is down, the constructive collaboration produced in an office environment cannot be replaced by video-conferencing only.
Eventually, people will go back to the office albeit in a different hours/day format.
As a result, the pent-up pressure will resume slowly
For now, the good news is: Tenants will take advantage of sliding rents (they already are) and the rent component will be a smaller portion of business expense. How can that hurt office users?
Purchase prices will tumble, and buildings will change hands; large multimillion dollars funds are being assembled to take advantage of the situation. It will be little bit of an ugly transition, but it will happen. And again 20 years from now, we will hear this conversation on how 2024 what such a great year to make a real estate move.
Author : Franck MORINEAU
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