Why office real estate landlords aren't panicking just yet – Financial Post

With tens of millions of employees working from home or laid off, the future of the workplace is now a primary concern for commercial landlords and tenants.

A recent report by Cushman & Wakefield (C&W) found that 73 per cent of workers would like their employers to adopt “some level of working from home.” Also, 90 per cent of employees believed their employers trusted them to work remotely.

But do these developments mean the end of “the office” as we know it? Not really. The report describes a new normal that will involve a “total workplace ecosystem” comprising more than a single destination and including a combination of virtual and physical places.

Critics of telework often argue that collaboration weakens when workers are confined to remote silos, but the C&W report suggests otherwise. It found collaborative work increased by 10 per cent with telework over the pre-COVID-19 period, with technological advances being credited for the big shift.

Roelof van Dijk of the CoStar Group sees two opposite forces simultaneously pushing and pulling on the demand for office real estate. On the one hand are the pandemic-related social distancing regulations that are behind the surge in working from home. As the number of workers, especially in the knowledge economy sector, continue to telework on most days, the demand for office space is likely to decline.

At the same time, social distancing regulations will require more space to be maintained between workers. The same floor space in the future will, therefore, hold fewer workers if they are spaced farther apart. Hence, even if a segment of employees continues to telework, spatial distancing measures requiring more space per employee should counteract the decline in demand.

In the short-term, landlords are unlikely to reduce rents drastically if the demand for office space decreases. It is also unlikely that office tenants will seek additional space if social distancing measures mandate more space per employee. Instead, tenants are likely to stagger schedules by having workers come in on alternating days or at different times, allowing tenants to maintain the same amount of space until their leases are up for renewal.

Office real estate markets present a mixed picture for demand today. According to data provided by CoStar Group, vacancy rates are exceptionally low in some parts of Canada, where the demand for office space is high, and the supply has not kept pace. While in other places, ominous signs of growing weakness are apparent.

CoStar data shows that office vacancy rates in Vancouver averaged 2.9 per cent in the first quarter of 2020, down from 3.3 per cent a year ago. While Vancouver’s office real estate market is tightening, Calgary’s shows increasing signs of weakness. Already, Calgary’s vacancy rate in the first quarter of 2019 at 14.4 per cent was more than four times that of Vancouver. That vacancy rate increased to 15.6 per cent in the second quarter. By comparison, Toronto’s office vacancy rate was around 4.4 per cent in Q1, down slightly from 4.7 per cent in the same period last year.

What may happen in the future depends on current local market conditions. For Canadian office markets as an aggregate, CoStar is forecasting an increase in vacancy rates from 6.2 per cent to 7.1 per cent a year from now. Local office markets present a mixed picture. Vacancy rates are expected to remain mostly unchanged in Vancouver and Edmonton but are expected to climb in Calgary and Toronto.

Commercial leases, unlike their residential counterparts, are of longer duration, often ranging from five to ten years. It may take up to a few years for most leases to go through renewal. A lot, therefore, depends upon the state of the economy in the near future. If local economies can shake off the pandemic blues sooner, one would expect growth in economic activity, an increase in hiring and a resulting increase in the demand for space, which may still be moderated by a higher prevalence of telework. If local labour markets fail to recover, and job losses become permanent, office markets are expected to struggle with or without telework.

Unlike landlords who hold retail real estate, office real estate owners are likely to fare better with rent collection. With malls closed during the pandemic, their tenants face massive cash-flow challenges, which compromises their ability to pay rents. The good news is that online retail sales are up for some retailers. The bad news for retail landlords is that a shift from brick-and-mortar retail to e-commerce would further lower the demand for retail real estate.

Whereas offices are also closed to employees except for essential workers, office work continues from home, thanks to telework. The business models of office-based firms are thus disrupted, but not discontinued. Hence, many office-based firms can conduct their business remotely and can meet their rent obligations.

A shift in demand for more modern and better-quality office space might also occur. Higher-end office real estate equipped with, for example, advanced HVAC systems and fast elevators, are more likely to adapt readily to social distancing requirements. In comparison, older B Class real estate may find it hard or prohibitively expensive to comply with regulations for improved ventilation and greater distancing between employees.

Telework may not be for everyone. The C&W report revealed that while younger cohorts, i.e., millennials and Gen Z workers, expressed the strongest desire for flex-work options, they found telework more challenging than older cohorts. Shared living arrangements, smaller dwellings, and a lack of dedicated space to work from home could be the reason for younger workers’ struggle with telework.

Real estate markets are in flux, and nothing about the future is known with certainty. Contingency planning based on probable future outcomes will allow smart landlords to cope with the changes heading their way. Waiting for a return to the old normal may not be a wise strategy.

Murtaza Haider is a professor of Real Estate Management at Ryerson University. Stephen Moranis is a real estate industry veteran. They can be reached at www.hmbulletin.com.