Is Office the New Retail?
The office market is still trying to find a balance between remote and in-office work. As long-term leases expire, office tenants are getting their first opportunity to redesign and right-size their workplace environment. This is occurring against the backdrop of a “tenant’s market”, a dynamic office tenants haven’t experienced for the better part of the last decade. Landlords have done a good job holding firm on asking rates and buying down the effective rent with various concessions, but I foresee this changing as we progress through 2023 and into 2024.
The office is far from “dead,” and the vast majority of business leaders agree that not only does office space play a vital role, but they strongly prefer employees to be in the office at least part of the time. Office properties are in a transition similar to that which retail experienced throughout the 2010’s with the rise of e-commerce and the “Amazon Effect”. Some assets will live to see another cycle, while others will not. This will be a much-needed cleansing for the sector and will pave the way for alternative uses, new investment strategies, and reflect changing tenant needs.
“Flight to Quality” has been the dominant theme, beating out “Convenience” and “Work-from-Home”. Initially, I hypothesized that suburban offices would be the big winners because of their proximity to residential neighbors, accessibility, open-air environments, and density, to name a few advantages. Fast forward three years, and office properties that have performed the best and retained the highest occupancies are those in which the ownership proactively maintained and renovated to accommodate the latest trends. In past cycles, tenants have used down markets to secure better locations that they otherwise couldn’t afford. This time around, tenants have all their options on the table, and the common denominator is “quality”. Properties that offer a full suite of amenities, such as cafés, fitness areas, conference centers, outdoor areas, and car wash & dry-cleaning services, are doing just fine and will live to see the next cycle.
The current banking crisis has added another layer of risk and uncertainty. The Fed, in conjunction with the six largest global banks, took swift action and appears to have backstopped this from becoming a broader systemic issue; however, the medium- and long-term implications have yet to materialize. Community and regional banks play a critical role in the commercial real estate market, both locally and nationally, and their health is closely tied to the overall health of the market. The events of the past couple of weeks have businesses and investors alike questioning the creditworthiness of their counterparties, reevaluating their loan maturities, and diversifying their depository relationships.
The office market is and will be in a period of transition and uncertainty for the foreseeable future. In light of these challenges, it is important for tenants and landlords to adopt a proactive approach. For tenants, this means starting to evaluate their lease well in advance, even if they plan to renew it. Time is your best friend and your biggest enemy. For investors, this means retaining existing tenants, paying down debt and considering opportunities that offer value and flexibility.