A significant unanswered question in commercial real estate is future demand for office space. With streamlining, downsizing, outsourcing, improved technology, cloud computing, and more employees working from home, will an improved economy necessarily result in more demand for office space? What will companies’ long-term space needs be? Will some have reduced office space needs even as they expand? The jury is still out.
Perhaps no industry sector has suffered more in recent years than the office market. According to the Colliers International 4th Quarter 2010 U.S. Office Market Report, the overall office vacancy rate was 16.1 percent. The recovery has begun, but there is a long way to go before office vacancy is back down below 10 percent. However, shifts in the workplace are indicating a “new normal,” which could mean some sectors of the office market will never recover. Could this be true?
A recent study conducted by Jones Lang LaSalle indicates that the current rule of thumb of 200 square feet (18.6 sq m) per employee may shrink to as little as 50 square feet (4.6 sq m) for some tenants by 2015. Peter Miscovich, managing director of corporate solutions for Jones Lang LaSalle in New York, says he believes this will indeed be the case—if not sooner, then later. “Some of my tech clients are already there,” he says.
“We are at an inflection point,” says ULI member Miscovich. “Economic, demographic, and technological factors will all influence the future of office space.” He speaks worldwide on the future of the workplace, and cites an array of indicators:
• Half of the American workforce will be millennials in 2014;
• Baby boomers will retire and paperless millennials will replace them;
• 40 percent of IBM employees work from a location other than an office at IBM; and
• Even something as seemingly insignificant as office space dedicated to filing has shrunk from 15 to 20 percent of office space to around 2 to 3 percent in many cases today.
Not everyone entirely agrees with this prediction. Ross Moore, chief economist for the U.S.A. at Colliers International, agrees that the workplace is changing. “Technology is finally getting in and shaking things up.” But he remains unconvinced we’ll see a wholesale shift in the office market, at least not as quickly as some like Miscovich predict. “It’s one thing for IBM to have a lot of people working remotely. Now if Procter & Gamble does it, then you’ll have my attention,” adds ULI member Moore.
Miscovich is quick to explain that offices and cubicles aren’t necessarily shrinking, but rather the need for each employee to be at the office is reduced. Thus, workers visit the hub office only a couple times per week, and therefore two or more employees can share office space, thus reducing demand for overall square footage. “You share the office space with coworkers who use it the other days,” he explains.
The basic premise for Miscovich’s argument is “how work will be done.” He believes demographic shifts in the workforce will be rooted in technology, the ability for work to be done from anywhere, and young workers’ willingness to work that way. He cites a client in New York, an advertising agency, which signed a new lease and went from 26 floors to a new lease on only six, while simultaneously adding employees. This is not an isolated trend. Across the country, brokers are seeing far more clients signing leases and needing less space rather than more.
“There will be big winners and many losers,” says Miscovich. He believes buildings that are tech-enabled, transit-oriented, green, efficient, and with amenities will attract tenants. Meanwhile, “Class B and C in the middle of nowhere in the suburbs will languish.”
Russell Ingrum, executive vice president and managing director of the investment properties/institutional group at CB Richard Ellis Capital Markets in Houston, and chair of ULI’s office development council, says the current office market recovery is led by energy, technology, and financial services. “Seattle, Austin, and the Silicon Valley are recovering well because of technology,” he explains, “and Tulsa, Denver, Dallas, and Houston are because of energy.”
As to the dire predictions of office space, “I do not put much stock in them,” explains Ingrum. “What most firms desire more than anything is to have office space that helps them recruit and retain the best employees. Who wants to work for a company that puts you in 50 square feet? It works well for some companies, but is not an option for most.”
Ingrum notes that there is definitely a flight to quality in the current recovery. In every market, the best assets are recovering first. Central business districts are most often the beneficiary, but it depends on the metropolitan area, as there are certainly suburban markets that are recovering well, too. Moore agrees with that nuanced assessment. “I don’t buy into the ‘urban great, suburban not so great’ mentality.”
Moore says there are certainly challenges ahead for office landlords. “It is a headwind, absolutely. Profits are on the line.” Moore says he believes if gross domestic product continues to grow at 3 percent and the United States adds 2.5 million jobs, there ought to be office absorption of 20 million square feet (1.86 million sq m) per quarter. If it is less, perhaps that will be an insight into future trends.
“2011 will be a crucial year,” he says.
Nonetheless, if Miscovich’s forecast is anywhere near accurate, today’s 16 percent vacancy rate will be largely immaterial as the best locations thrive and vast swaths of office buildings in subpar locations languish, never to recover. “The next 30 years will look nothing like the last,” says Miscovich.
Clearly there is no consensus on how future trends in the way people work will affect the office market broadly. The recovery may be masking some of these trends at present, but one thing is certain: a lot of people in the industry will be paying close attention.