Office demand comes back strong as inventory in space plays catch-up

If you’re not back in the office yet, you might be soon.

After a five-month lull, likely due to the highly contagious omicron variant of the coronavirus, new office demand surged in March. Barring another major setback in the pandemic, it will likely continue to rise, but the offices themselves will get a makeover as worker demands change.

The optimism in offices is already showing in the stocks behind the office sector. As rents rise and vacancy rates fall, earnings are beating expectations.

Demand for offices, measured by visits from new tenants, was 20% higher in March than in February and was up about 8% from a year ago, according to a recent report from the technology platform of commercial real estate VTS. Tours are considered a forward-looking indicator of new leases.

The office vacancy rate in the first quarter of this year fell 18 basis points from a year ago to 18.1%, according to Moody’s Analytics. It’s the industry’s first annual decline in five years and a marked improvement from an 18.5% vacancy rate at the height of the pandemic.

“Demand for office space this month is more in line with what we expect to see at this time of year,” said Nick Romito, CEO of VTS. “Looking forward, I expect we will continue to see demand fluctuate in a typical seasonal pattern, but to really break out of the prolonged period of depressed demand we’ve been experiencing lately, we’ll need to see demand exceed the seasonal standards over the course of several months.

Demand is slowly driving up rents. Asking and effective rents rose 0.2% and 0.3% respectively in the quarter, the best performance since the start of the pandemic, according to Moody’s. Annual rent growth also reversed its downward trend.

Despite the surge, however, new demand for office space is still only two-thirds of its pre-pandemic average, based on the VTS metric. Boston, Chicago, Los Angeles, New York, San Francisco and Washington, DC are the top regional winners.

And while the signs for the sector are bullish, office-related stocks, mostly REITs, are still mixed.

Boston Properties, Hudson Pacific, SL Green and Empire State Realty Trust are all still below pre-pandemic levels. For example, Hudson Pacific fell 40% at the start of the pandemic, then slowly started to recover. It’s up 28% from the pandemic low, but it’s still in the red year-to-date.

Some, like Boston Properties, have returned within the past year. Boston Properties reported better-than-expected first-quarter earnings on Monday.

“As rent growth takes time, demand for space gives BXP reassurance that COVID is over as tenants bring their employees back, which should accelerate the rebound in occupancy, providing upside revenue “, wrote Alexander Goldfarb, REIT analyst with Piper Sandler in a note to investors in March.

A new survey by CBRE of 185 companies using offices in the United States found that 36% of employers said the return to the office was already underway. Just over a quarter said it would be by the end of June. Around 13% said a return to work depended on their employees and 10% were still unsure.

Offices were still less than half full in April, at 43%, according to the VTS report. But it marked a pandemic high.

When workers return to the office, they can expect to see significant changes, not just in cleanliness and air filtration, but in the way they run their business.

CBRE’s survey found that employers were pointing to more office technology tools to improve video conferencing, as well as occupancy sensors and contactless options. There will be more so-called “free” seats. Nearly two-thirds of companies said they intend to use open offices rather than assigned offices or cubicles.

There will also be widespread hybrid working, with 70% of employers saying they intend to allow workers to be both in the office and remote. Almost half said they wanted it to be an equal mix. For this reason, they expect more flexible office spaces. Just over half of employers said they would add different forms, from open offices to “dedicated floors indistinguishable from their traditional office space,” according to the report.

“This flexibility is desired for a number of reasons, including the ability to scale up and down, to give employees more choice about where they work, or even just to preserve capital,” said Julie Whelan, Global Head of Occupant Research at CBRE. “But employees get productive space in good locations with generally great amenities and experience.”

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