Part Two: What we know, and don’t know
Although the adjective ‘unprecedented’ has been largely overused this past year, there really is no better word to describe 2020. It was an unprecedented global pandemic that kicked off the year; an unprecedented one-quarter plunge in U.S. GDP; unprecedented fiscal and monetary policy response; unprecedented work from home surge; unprecedented peaceful and not-so-peaceful protests around the country; and finally, and most importantly, unprecedented speed to a medical solution to COVID-19. As we flip to 2021, and as the vaccines are now getting rolled out to millions each week, we are also beginning to feel, perhaps, an unprecedented level of optimism. The road ahead will be bumpy, in particularly the first few months of the new year, but there is light at the end of the tunnel.
In a series of three snapshots focused respectively on the economy; key office trends—what we know and don’t know; and a 2021 outlook, we explore some of the factors that will shape this calendar year.
Part Two: U.S. office sector: what we know, and don’t know
It is an understatement to say the office sector outlook remains unclear. In fact, there are still many unknowns that will influence the shape of the office recovery for years to come, such as the path of the virus itself; the rollout of vaccines; school openings; employee and employer confidence; and the work-from-home (WFH) dynamic. So, rather than speculate, we are sharing a few key trends that we do know lay the foundation for a possible path forward.
- The office leasing fundamentals were severely damaged last year. We observed 104 million square feet (msf) of negative absorption in 2020, which is already more severe than what we observed during the Great Recession. Sublease space soared—about 50% of the negative absorption observed last year came from newly added sublet space. Office vacancy rose from 12.9% pre-pandemic to 15.5% by year-end. When we line up the office-using job losses that occurred last year (1.15 million) with the amount of negative absorption, it suggests that vacancy will continue to rise—at least for the next couple of quarters—as businesses continue to right-size office footprints and WFH trends filter through.
- Most companies will not go 100% remote. According to multiple studies and surveys, conducted both by the CRE industry and outside of the industry, most companies are not moving to a 100% remote model. There may be some companies that return to 100% in-office and some that experiment with 100% virtual, but these will be the outliers post-COVID-19. Although there is no consensus on the optimal balance of remote vs. in the office, and it will undoubtedly vary greatly based on many factors such as the business itself, the industry, the job function, personnel and other factors, most surveys show that employees and employers expect to spend 2-3 days in the office post-COVID-19.
- Most businesses are not fleeing CBDs. According to our data, in a typical year, CBDs account for 30-40% of all leases, and in 2020, CBDs again account for 30-40% of all leases (32.6% to be precise). Of course, 2020 is a difficult year to analyze, since it is a much smaller sample size, but based on the data we have, there has been no evidence that businesses are fleeing CBDs en masse. Multifamily rental data does show more strength in the suburbs in 2020, which makes sense since much of the benefits of living in a city have been temporarily eroded by the pandemic, quarantining and government lockdowns. This could reverse back towards CBDs and city centers more quickly than office occupancy can pivot given the relatively short length of multifamily leases. Bottom line: it is premature to conclude that a permanent shift to the suburbs is occurring beyond the norm (we did expect some millennials to go there at some point) as it seems quite intuitive that there would be some migration out of densely populated cities when you are in the middle of a global pandemic.
- Most businesses not fleeing big cities. Likewise, there is no evidence thus far that the majority of businesses are leaving large cities for small cities. In a typical year, about one-third of all office leasing in the U.S. occurs in gateway cities (Boston, Chicago, Washington, DC, Los Angeles, New York, San Francisco), and in 2020, it was about the same, 32%. Likewise, there is no evidence that investors are also fleeing gateways either. Office sales activity was down sharply virtually everywhere in 2020, but it was down equally in major markets vs. non-major markets. If anything, the gateway cities gained market share last year accounting for 38% of total U.S. sales in 2020 vs. 36% in 2019. That said, there has been some movement and relocations to the sunbelt region and to lower cost markets, but that was a trend that started well before COVID-19. The key question is, will migration patterns fundamentally shift as a result of COVID-19 or from a larger adoption of a decentralized, agile workforce? Again, too soon to say. We will be monitoring migration data closely this year.
We will continue to closely monitor, evaluate and report back on these key trends all throughout this year and beyond.
Up next: U.S. Office Sector Outlook in 2021