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The Economics of Office Real Estate
Office space crisis ahead? $413 billion in assets at risk for commercial real estate owners. What can they do to avoid this fate?
Picture an office....
What do you see? For most of us, the word ‘office’ conjures images of gray, dull spaces with rows upon rows of cubicles. These conventional office spaces we all know (and don’t really love) have historically dominated office real estate, but things have shifted, and they just aren’t working anymore.
As more and more companies embrace hybrid work models, demand is growing for more diverse workspaces that can support different activities. To foster collaboration, productivity, and connection into the future, organizations want spaces that are purpose-built for flexible work. However, much of the existing supply of office space isn’t up to the task.
A quick Econ 101 refresher:
In any market where there are buyers and sellers, supply and demand curves intersect at a single point called the equilibrium, which represents the optimal operating point for that market. When one curve shifts, the other must also shift to meet at a new equilibrium. Applying this framework to the market for office real estate, the supply side consists of commercial office owners & operators, and the demand side consists of occupiers, who are companies that use office space. For the last few decades, the market was operating at an equilibrium point where most companies worked in conventional office spaces five days a week. Obviously with hybrid work here to stay, this is no longer the case: demand for office space is changing, and supply must adjust accordingly.
Let’s take a closer look at what’s happening on the demand side of things. Occupancy rates of office space dropped from 95% in February 2020 to just 10% by the end of March 2020. Recovery has been slow: occupancy rates have crept back up to just 47% by November 2022. The graph below highlights the steep decline in total square footage of office leases signed over the last few years:
Why? Hybrid work is becoming the norm, as 87% of employees report that they will work flexibly if given the opportunity. As occupiers that are implementing hybrid return to offices, they need less space, but perhaps more importantly, they need different types of space. A crucial element of an effective hybrid work model is a workspace that can support collaborative work activities, and cubicles aren’t going to satisfy occupiers’ changing needs.
On the supply side of things, the drastic changes in demand for office real estate have intensified challenges for suppliers, including low occupancy rates, high rates of vacant conventional office space, and lack of technology. To quantify the impact of these challenges, owners and operators in the U.S. are facing a potential $413 billion value destruction in the long run. Older buildings are particularly vulnerable, with many pre-1990 office buildings being targeted for residential conversion.
What does this mean for owners and operators of commercial offices?
Collecting utilization and occupancy data will be absolutely critical in order to meet this new shape of demand. Data provides visibility into tenants’ needs today, as well as their needs for the future, helping owners & operators understand measurable outcomes and align their mission and business objectives with that of occupiers across their portfolios. A better understanding of tenants' needs allows owners and operators to offer and manage optimal bundles of conventional and flex space offerings, driving higher revenue and tenant retention.