By Sam Delisi, Global Head of Property Management Services for WeWork
Overview:
The CDC started issuing travel advisories about COVID 19 in early January of 2020. On March 16th, 2020 the administration issued social distancing standards that were to last for 15 days and on March 29th based on the recommendation of the CDC the timeline was extended through the end of April 2020. The speed of how quickly a pandemic can spread and literally effect all of our lives and the global economy is truly unprecedented.
The effects of the social distancing standards and the shelter in place orders by state and local governments have shut down the US economy. The federal government has enacted 3 separate initiatives to soften the economic blow. Based on current models the virus will peak in mid-April and if social distancing and the measures by the medical and pharma communities make progress one can begin to see the light at the end of the tunnel.
The future of the Office Property market and workplace is speculative at this point. Will this usher in a new era of work from home employees? How do we make employees feel secure about their wellbeing at work? Will fear of this and future viruses mark the end of the open office environment? Will this be the end of Space as Service providers or is the beginning of the second act? What will the impact be due to tenants considering the Force Majeure clauses or clauses that would include Governmental Action in their leases? We will explore these questions and more herein.
The Market:
The good news that Global and US office markets were broadly in good condition going into the COVID 19 Crisis. The vacancy in the US was below the historic average in most markets. 91% of leases in the U.S. are 2 Years or longer so vacancy rates should not change dramatically in the next few quarters. The market has been very disciplined in both supply side and regarding loan to value ratios (LTVs) and as a result the office industry is in good shape heading into what is going to be a recession the length and depth of which is to be determined.
Landlords are already fielding calls from tenants that are aggressively pursuing rent relief and or lease restructures. Unfortunately, as in all recessions there will be tenant bankruptcy’s that landlords will not be able to avoid. For firms that have temporary setback or want to change their occupancy strategy the blend and extend strategy is back. Some tenants are looking for rent relief due to loss of business others are re-evaluating their current workplace strategies regarding work from home policies and they may need to reconfigure their office’s to give their employees a sense of personal space as interior designers scramble to develop more environmentally hygienic workplace trends.
Most office buildings have first floor retailers. Virtually all of these tenants are or will be looking for rent relief and many will not survive this downturn. On a prorata basis retail tenants generally pay higher percentage of rents then their square footage would suggest. Losing these tenants has a big financial impact as well changing the buildings image in the market and it diminishes support for the office tenancy.
Well capitalized owners will be able to work with office and retail tenants improve rental rates in the long term, extend leases and add value to their properties. Owners that are not well capitalized will lose tenants who have short remaining leases terms and experience sublease space for some of their longer term leases which will negatively impact the property’s value as underwriters try to value the building.
During recessions capitalization rates go up and values will soften. There is a lot of capital on the sidelines and with low interest rates, value add investors will take advantage of these buying opportunities. As a result there should be some sale transactions later this summer increasing through year end and beyond.
Occupants/Workplace:
The trend to open Workplaces has changed the market for office space. Ratios of 250 sf per employee have dropped to 150 sf per employee and many firms and space as service companies were pushing the envelope to 100 sf per employee. These new standards created amazing efficiencies and cost savings for employers. The average workspace (desk area) was reduced to 46 sf with common elements like phone booths, huddle rooms, coffee stations, conference facilities, game rooms and community kitchens making up the other 100 sf. The goal of these plans was to improve collaboration and give employees a sense of community and lots of options to work from anywhere in the office. Free addressing also became popular, meaning there was no assigned seating for each employee which helped to increase efficiency and when combined with some amount of worker mobility meant that the ratio of desks to employees was less than 1 to 1.
In the post COVID 19 era asking employees to re-enter this style of working environment would seem to cruel and unusual punishment. The shared spaces would appear to be havens for spreading viruses and may trigger some form of PTSD for those who have been affected by the pandemic.
Interior designers are already studying plans to evolve open office designs to something that will make users feel better about the work environment. Providing more personal desk space per employee thinking about how to create a more hygienic environment from products with anti-microbial surface’s to specifying better air filtration and circulation. The future of these new designs will be exciting to see and should be a big driver of innovation and new technology.
Will working from home become the wave of the future? As we discussed earlier so far, our massive work from home experiment is going pretty well. If this is to be adopted as a standard practice what % of the work force will be permanently working from home? That will be determined on a case by case basis.
When you combine increased square footage per employee and fewer employees working from offices the net effect of space required may be no net change. That of course would be a great scenario for property owners however it could also reduce demand.
Property Management Response:
Over the past 2 weeks we have spoken to leaders in the property management industry and they were very focused on the here and now. They were interested in the health and safety of their employees, vendor partners and their tenants. Pre-social distancing and shelter in place edicts they were deep cleaning suites where tenant employees contracted the virus. Now they are operating with essential personnel only but keeping their buildings open. Keeping the building open is important for the tenants who are considered essential services and may help defend against potential Force Majeure issues for the owner.
The current phase of the property management has to do with planning for how to reopen and provide customers with assurances and some sense of security regarding their buildings level of environmental hygiene when they return to the building. There will be more from the CDC on approved cleaning standards. Some properties may add a daytime shift of cleaners that will be responsible for sanitizing restrooms, kitchens, coffee rooms and surfaces throughout each suite. Some customers (at their cost) may opt to add their own full time cleaner to only focus on their offices.
Managers should focus on CDC and ASHRAE standards and add more outside air to the mix to improve the quality of the air inside the property. Air filtration will have increased importance as filters that trap or eliminate viruses and other microbes will add value to making customers and their employees feeling safer at work and differentiate the property in the market.
Managers will need to increase their communications with their tenants to let them know all that they are doing to improve their employee’s well being. Managers will need to be proactive to keep their property safe by making sure that sick employees don’t come to work. Some corporate facilities will take employees temperatures as they enter the building others will install technology that will be less intrusive but will also monitor people temperatures as they enter the building. These could raise privacy issues.
Managers will need to look for ways to reduce energy costs and the cost of non-essential personnel during the Social distancing phase of the crisis. Most of what is being contemplating above will increase operating costs and, in some cases, increase capital spend as buildings that need to refit their mechanical systems for better filtration and more fresh air.
Lastly this is the time to reach out to your tenants. The building managers should be speaking to the office managers, but leaders of the management services companies and property ownership should be reaching out to the C-Suites of the tenants in their portfolio’s. These communications will be critical as it is in crisis when new relationships can be created, and existing relationships can be strengthened. Pursuant to our discussion about the market the blend and extend transactions will go better if there are established relationships throughout both organizations.
