I am not understanding a lot of real estate execs (mainly boomers but also some Millenial & Gen X) mindset as it pertains to the state of the office market. I keep hearing them saying that “office will come back” or it’s “still too early to tell” or even “there will always be a need for office, demand can’t just vanish.” These execs are thinking with their hearts and not their minds. They want office to improve but the numbers and evidence say otherwise. See below… Office Occupancy/Leasing: We are about 4 years removed from the onset of COVID, and about 2 years removed from when pretty much all firms required employees to return to office (whether it be full time or hybrid). At this point, I do not see office leasing or occupancy numbers improving. I think this is the best it will get. And companies that have aggressively added talent to their workforce over the past 5-10 years will continue to trim, which lessens the need for more space. Office Underwriting: I’m hearing that TIs and LCs have become egregiously expensive just to even have serious discussion with a potential tenant (NY market). Combine that with minimal or flat rent growth, abundance of supply, and how capital intensive office is, this is a recipe for disaster which often leads to deals not making sense. Office Valuations: There are some office markets that have bottomed out (e.g. Houston & San Fran) and those markets can only get better because it’s already so bad. However, in places like New York, we have an adequate amount of price discovery for all types of office products in multiple locations. Whether it be from lender-induced sales, foreclosures, or just sellers trying to recoup some money from a straight up sale. Point is precedent has been set on where office is trading PSF. Just because sellers don’t like where valuations are, it doesn’t mean they don’t exist or aren’t sensible considering market conditions. Not saying office is completely dead but it’s mostly an unattractive proposition unless the basis is just too low to pass up. But even that requires complex financial engineering or impressive negotiating tactics. Yes, we know Trophy Class A+ is performing well but 99% of office is not that. You can’t slap on some new paintings and design in lobby and call it Class A+. Gotta be 2016 vintage or newer, floor to ceiling glass, high ceiling, open floor plans, fully amenitized, and well located. Can someone please opine or correct me if they believe I’m wrong or I am missing something?
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As someone who tried to sell class A with national credit tenants for 8.5% and got laughed at, I agree with you.
How much lease term was left?
7 years all freshly signed
The only way anyone is buying is if basis is on the floor.. with really really low entry points, it allows a new owner to reset rents to a much lower level, which lets firms take more space for amenities/meeting spaces etc. Office will never be what it was, but there is still value in those class B/C spaces in urban cores, the rents just need to come way down
I think it'll be a shift. I do think companies will force employees into the office, at least on a hybrid schedule. This being said, during the great construction phase, cheaper land was bought in suburban areas outside major metro areas. I could see the vacancy dwindling there, but in the city nearby, it would be higher as people leave for lower-cost amenities that are also newer and cheaper rent. I don't think the hearts of cities will come back until the owners and PM groups realize that nothing will move till they accept the actual value of their properties.
I don’t follow…who isn’t back into office yet? Even tech firms have their people in 3x a week. Media and advertising are back 3-4 days. Financial institutions are in 4-5 days. Any role that is still remote now will probably be permanently remote. In other words, there isn’t any more upside given that RTO has been in full effect over the past 12-24 months.
So in MidTown down to the Wall Street area, a lot of that was very small marketing, smaller law firms, smaller business in those older businesses. I know a ton of them left. My BIL was at two different ones and both left after their lease renewal came up. They are fully remote. Other bigger firms moved to like Tysons or Arlington in the DC area. A ton of bigger firms moved to Media and King of Prussia in Philly area. They are in office but let for new buildings with cheaper rent. Who is going to back fill in the heart of the city.
Who isn’t back into office yet? People who are not working in class A office spaces in Manhattan? Even with the same company, if the mandate is say 4 days a week in the office, people in the NYC office will show up 4 days a week for optics as that’s where the execs are but people in the satellite offices in the suburbs across the country will “work” at the office 4 days a week but we all know they are not spending 8-12 hours a day in the office. People come in, swipe and leave. Some are here for just 1-3 hrs. Some come in at 4-5 PM, swipe and leave. Does this really help the office market? Whether it’s industrial, office or retail, usage matters. Owners walk through the space to see if tenants are fully utilizing their space as this is a good indication of whether they will renew or downsize.
What are you talking about? There is no more temporary WFH, whatever we are seeing occur now is permanent status quo going forward.
There is no “companies will force employees into the office” - it’s done. COVID was 4+ years ago. What we see now, is it.
Pretty sure most BB's and IB's just pushed on FINRA to make it a rule for people to be in the office.
Great threat and posts!
It is important to note that Ares and RXR were applauded for launching their JV targeting office, yet it has been completely stagnant.
I found RXR’s stance to be hypocritical. RXR doesn’t own any Class A+ in NYC. Their portfolio is struggling because it consists of Class B/C (albeit in good locations). They have been turning over keys on their office assets and struggling to make debt service on others.
So now their stance is they can take advantage of “market dislocation”? They haven’t even shown that they know how to navigate the current office market as it pertains to their equity ownership interests. Why should you be trusted to invest new money? Yeah doesn’t fly with me. Any investor dumb enough to throw money in that fund shouldn’t be surprised if they lose money.
If you have the balls to buy right now the basis is phenomenal. You will not get debt though. One of my favorite jon gray quotes is capital structure is temporary but the price you pay is forever. When we’re talking $200/sf for any use in downtown LA and SF that feels decent…
Realistically though, it will be a mediocre market probably for 8+ years. Then I’m going to take a guess that the narrative will shift just as it has on retail in this moment.
That is unless AI has eliminated every back office (or ours) job on the planet in 8 years…
I would not be surprised if AI eliminated alot of these. Couple this with remote/hybrid work, I think the trajectory upside for office is limited, but who knows.
As someone from LA, I don't know if downtown LA ever will come back (sadly). West LA/South Bay/North LA are all closer to where everyone wants to live, and much more appealing. I have seen plenty of companies shift their attention to offices in those areas. Downtown SF is a different story though. As soon as they bother to clean it up, I think it will be fully back.
I work for an office operator and everything you outlined is correct. Even the most hard-headed execs at our firm have capitulated. We are just playing defense and trying to lower our basis/extract as much distributable cash as we can before the next "event", whether that is a loan maturity or lease expiration/termination. Institutional capital has left the space and there is zero liquidity. The pre-COVID demand is never coming back and the majority of office space is obsolete. Much of the Class B/Class C space is just worth the dirt less the cost to scrape.
Any sense of how the asking price for vacant space compares to pre-covid?
We had a renewal negotiation last year on our office. Occupancy in the building is 50% vs. 90% pre-Covid. We expected a serious drop in rent on the renewal but only got offered a small cut. Took the opportunity to upgrade to a space across town that we're getting at a meaningful discount to pre-Covid pricing (I don't know exact % discount but a legit reset . . basically upgrading from B space to A space without spending anything extra).
Honestly, not that much. In general, landlords will do everything they can to preserve the face rate even if it means giving a crazy amount of concessions. We will see some big drops when these properties change hands via short sale/DIL/foreclosure and the basis is reset.
Best office market in the country feels like Lakewood, NJ and I’m not even kidding
All the real estate money there is forcing everyone to go into the office so their values remain high.
I would love to hear any Office bro convince me why anything outside of prime Class A CBD office space, will return. Outside of inflation/continued expense pressures (insurance, etc), 2024 is turning out to be the most normalized post COVID year to track against going forward as it relates to historical data. If you’re office ain’t already back, I don’t see what the hell is going to change in the foreseeable future.
Even Prime Class A in CBD is very very limited in NYC. There are less than 10 true Class A CBD office buildings in NY (e.g. Hudson Yards, Manhattan West, & One Vanderbilt). Those types of buildings are enormously difficult to develop between price of land, scarcity of land in CBD, cost of construction, increased hard costs due to inclusion of full suite of amenities, AND having to pre-lease the building prior to construction in order to get construction financing (extremely difficult but not impossible to get financing for spec office even if it is Class A in CBD).
You do realize that there is like 50 - 60M sqft of class A office in Manhattan. People seem to think that the office pool can only grow. The reality is the land is what is expensive. The low grade class B, C, and D office space will essentially go away and everyone will move into Class A buildings. A company that had a 350K sqft lease will likely have 50K sqft in the new world. They will actually pay MORE per sqft but less overall and buildings will go from having 30 tenants to having 100 - 200 tenants depending on size. The office isn't just a place for midwits to work out of so their bosses can keep an eye on them. The office is a setting for collaboration to happen. This collaboration is what drives the enterprise value up.
Future potential hits to US office that haven't been priced in yet:
(1) VR/AR making remote work, remote meetings much more seamless and effective than they already are in the age of laptops, high-speed internet, and Zoom.
(2) white-collar outsourcing. Kids around the world grow up learning English by watching Youtube videos, generating a massive pool of cheaper potential workers overseas, whose ability to plug into the working environment is enhanced by (1).
(3) AI reducing the need for white-collar workers in general. More speculative but very possible.
4) Not enough younger talent to replace the boomers, will most likely shift back to an employee market in next couple of years ( and by and large they want remote/hybrid)
Interesting stat I read - class A leases signed pre-covid have a WALT of 6 years.
We might not be at the bottom yet. Tenants rolling will continue to downsize from their existing footprint the second they get an opportunity.
Good point. We often forget about those who signed leases (in Class A/B/C) right before COVID in ‘19 and ‘20. Definitely plausible to see firms downsize, go fully remote, or relocate.
LOL
My F500 is the anchor tenant on a huge new-build commercial space in Manhattan (on top of several existing big commercial office spaces in the city) in a circa 2019-era lease
they are seeking sublessors and do not plan to ever fill the space
plus our existing offices are super empty all the time despite RTO mandates
given typical length of commercial leases... you haven't seen the bottom yet
This idea that office is dead is what is really odd to me. OP talks about Boomers and their belief that office will come back. But at the end of the day the gen z idea that the office will never return is just as if not more delusional. I don't think you understand how generational wealth and power control works. You are the kids of Gen X, the smallest generation besides your own. You will work for the biggest generation since the boomers who are a wildly social generation. Your bosses will make you return to the office.
Does this mean that the office will be as important as it was before? No, but this idea that no one will ever go to an office again is fucking delusional and is a side effect of a generation raised on screens that have no idea how to hold a conversation with people in real life.
If younger generations are raised on screens and have no idea how to hold a conversation with people in real life, that isn't exactly bullish for office in the long term. The younger generations will eventually be in charge and will shape the working world according to their preferences.
Sort of like how older conservatives ridiculed progressive college "snowflakes" in 2011 and gloated that they'd "learn how the real world works" when they graduated and got jobs, but instead the snowflakes got jobs and made their office environments more like the woke college environments they'd left.
I am not saying this is wrong. But the timeline doesn't make any sense. People are acting like office is going to completely die off in 5 years. In reality office will always be a thing. It just might become a niche market more akin to self storage rather than a mega asset class. I personally think it is one of the best asset classes around right now mostly because the locations are amazing, many of the assets are selling at less than scraped land value, and tenants are contractually sticky for sometimes decades or more. It is a great play for people like myself of who look at things from a multi generational basis and our goal is to own high quality land with assets that can cover their own costs while eroding cash deployed basis. I don't need a 18% IRR. In the long run this is why family offices win. They are well positioned and structured to take advantage of market disruptions, specifically long term market disruptions.
https://www.brookfield.com/news-insights/insights/misunderstood-us-offi…
In the US there is approximately 4.6B sqft of office space, this is a bit misleading as the number is actually higher than this but doesn't include the imbedded office within other asset classes most prominent being industrial. Regardless of that there is ~500 trophy class office towers in the US totaling 238M sqft of spcae according to Brookfield, this is likely under reported due to a conflict bias on their part. But let's say the total is really 350M sqft of trophy class assets. The current office utilization is said to be 25% - 30%. This means that office utilization is north of 1.15B sqft, you can continue to maintain 100% occupancy of that 350M sqft of trophy class assets as well as ~850M - 1B sqft of Class A office.
It goes back to what I said multiple times when discussing office with people here. There will always be a demand, and as vacancies rise tenants will reduce their space and increase their quality. If you think that the RE team at F500 companies are just going to willingly give up their budgets in exchange for a few extra pennies of stock price you are uninformed about how human nature works. They might trim some of their office budget but it will unlikely be ever completely erased in within the next 100 years.
I think you are splitting hairs or don't understand exaggeration. No one (not even OP) is actually saying that office will be 100% dead and there will never be an office building in the world again...what I think OP and most on this thread are saying is that Covid/wfh has fundamentally disrupted the relationship that companies/employees have with office and the disruption is permanent. Meaning that companies and office owners need to accept this as a the new normal and not lie to themselves that office is going to rebound anywhere close to pre-pandemic levels. When rent that was $100/SF pre-covid drops to $25/SF, yes...technically there is still "demand" for office as someone is willing to pay $25/SF, but the demand has drastically decreased, which means there will be a lot of vacant office space. I live in a Tier 1 market (LA, DC, Bos, NYC) and the office situation, esp class B and C, is becoming a real issue that the city needs to address. There have already been a couple smaller class b/c office buildings in great locations that have traded at a 50%-75% discount. In 2021, 1 of these buildings was purchased for $14mm and just sold for $4mm...this isn't the tech industry...real estate doesn't rebound from that. That kind of shift in demand is here to stay, which means the number of office buildings will decrease drastically. This has dire consequences for cities across the US. In my city, commercial real estate taxes accounts for ~12% of the city's tax revenue. That's a lot of city services that are going to need to be cut. Unfortunately the mayor and city council are a bunch of idiots and are just kicking the can down the road or burying their heads in the sand. I mean by your definition, technically Blockbuster is not dead yet as there is still one in Oregon...
People at one point in time also thought the idea that most people would be working on farms forever. Remember that generational knowledge dies very quickly for things like this. NYC is a legacy of physical infrastructure regulation changes that resulted from the pandemic of 1918. How many people even know that there was a much more disruptive pandemic in 1918? Let me tell you, the answer is really fucking small considering that the advice given out by the CDC was to wear masks for this respiratory pandemic this time. Because in 1918 it is estimated that the death rate was 30 - 40% higher because the advice was to wear masks then as well.
My point here is that I give it a decade or two and people will have forgotten about covid entirely. Go out a generation in leadership and people will not even think about the impacts of covid on the work environment. We had a radical shift in work because the people who were in positions of authority were the most at risk from covid. Not saying that things will ever go back 100% to pre covid reality in terms of office utilization. But to think that the changes brought on by covid will be 100% permanent is fool hardy.
It’s all a bunch of bullshit. Ever since Covid happened companies don’t see the point in office space. The only reason why they’re forcing employees to go back to work is because they need to explain themselves to shareholders as to why productivity has been so low and they use work from home as a scapegoat.
At this point office space is going to be leased to real estate companies who still want to believe these beliefs for their own benefit. Multilevel marketing but within it their own industry. No wonder cap rates are so high along with vacancies.
I honestly have no idea what you are talking about. Why would real estate companies be the only ones leasing office space? The entire real estate industry isn't just one group chat where Blackstone suggests to the group that real estate companies should rent out as much office to prop up the industry...each company will assess their own need for office space and rent accordingly. I would argue that most real estate companies agree that pre-covid office demand isn't coming back nor anywhere close to it. But there will still be a demand for office space from all industries, including tech...just significantly less. Cap rates and vacancies are high because of WFH and less need for office space. I genuinely do not know what your point is nor what you are trying to say. If you truly believe that there is absolutely 0 need for office space then you're an idiot and maybe this is a sign that you should stay in the IB Forum?
..
The reality is that the office environment completely changed due to COVID. If it weren't for COVID, office would still be a respected asset class . That's neither here nor there.. But the office problem we are now facing is an over-supply problem...
Many people are going to lose money (including lenders), but eventually we will hit a new equilibrium. Cities / downtowns.. will take time, but eventually buildings are going to be converted (for ones that can.... likely less than 10% of the underlying supply and certainly a theme that is, more times than not, economically unfeasible), some will be torn down. Some will continue to be weird leasing environments but will lease space to really cheap tenants...
Tier 1 products in core markets will "recover." Tenants will lease space. Even with forever hybrid companies, they still need enough office space to cover "Easter Sunday" if you will. While they might not ever have the same pre-covid utilization rate, they still need space for when they need it.. Board meetings, important meetings, team collaborations, etc. I say "recover" because there will still be pain and even tier 1 markets, companies are going to lose money. But eventually the math will find a way to work itself out, and office will be an acceptable asset class (albeit, a much smaller one compared to pre covid).
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