Developers are building more office buildings today than at any point in the last decade, but the changing nature of the work could threaten long-held beliefs about the way the office market will behave as we enter the next decade.
The office construction pipeline in the U.S. at the end of the third quarter was 118.5M SF, the highest point it has reached in this economic cycle, according to JLL.
All the while, the number of U.S. workers who actually report to an office — and the average space they occupy when they get there — is dwindling. Experts ascribe the reasons for the seemingly illogical divergence in office supply and demand — a gap that figures to widen — to a host of reasons, but they all come back to one connecting factor: the millennial worker. Millennial workers, the thinking goes, want warm, attractive offices replete with amenities. When they don’t get it, they work somewhere else — from home, a coffee shop or another company’s office.
That’s why office construction is continuing at such a fevered pitch: only the newest buildings have been deemed good enough to get companies to sign long-term leases. Most of the nearly 120M SF of offices being built today already have some future tenants committed to move in when they open up.
The question for the future is: What happens to the buildings they leave behind?
“That means hard times [are] ahead for commercial real estate,” said Diane Mulcahy, a consultant, lecturer and author of the 2016 book The Gig Economy. “The traditional office model doesn’t really meet the needs of today’s workforce.”
By and large, America’s office stock is evenly split between prime offices and more affordable space. As of 2019, there was 2.8B SF of Class-A office space and 2.57B SF of Class-B space, according to data compiled by Transwestern. Vacancies in both have also trended close together since 2010, with Class-A seeing 13.5% and Class-B at 11.5%.
Corporate office demand is where the stark difference becomes apparent. Absorption from 2010 to 2019 — the amount of space leased by companies against what they vacated combined with new supply — was nearly 265M SF, eight times the absorption rate of Class-B space for that same period, according to Transwestern data.
The gap is only widening. Class-A offices nationally recorded positive absorption of 35.2M SF in 2018 and 32.8M SF this year, Transwestern found. At the same time, Class-B offices experienced their first two years of negative absorption since 2010, hitting -4.7M SF of absorption in 2018 and -10.1M SF this year.
“The demand for Class-A and top-end space, the demand is still there and I don’t think that is going away,” Colliers International Director of National Office Research Stephen Newbold said. “The challenge becomes not in leasing the new space … but if someone moves out of a tired Class-A or older space, as a landlord, what do you do to backfill that?”
The Worker Paradigm Shift
An increase in teleworking, the explosion of gig workers in the economy, open office plans and coworking are all influencing how much space companies are using and will use in the future.
The gig workforce — anyone from Uber and Lyft drivers to social media monitors, IT contractors to freelance journalists — made up 34% of workers in the U.S. in 2016, according to an Intuit study. By 2020, that percentage is expected to reach 43%.
Since 2005, the number of full-time employees who regularly work from home has grown by 173%, to 4.7 million people, according to the consulting firm Global Workplace Analytics.
“I think it’s no secret that workers are increasingly demanding flexibility … and to work from home,” Mulcahy said. “Workers are the ones driving this trend. Companies are incredibly slow to move toward a remote-work option. Long-term leases on real estate make less and less sense in a world where you have a flexible workforce.”
Accounting and consulting giant EY, formerly Ernst & Young, was an early adopter of flex office and teleworking even before the Great Recession. It has seen its contract worker base grow and its office footprint moderate, EY Global Real Estate Leader Trex Morris said.
Of its 300,000 workers around the globe, more than 15% are contract employees. It is “a big number, and it will continue to get bigger,” Morris said.
All the while, U.S. businesses have moved their office designs more toward open office plans — even if workers hate them — and coworking/flexible offices.
Put another way: Employers are making choices by which they are able to shuffle more employees into less real estate. As of last year, the average square feet of office per employee was 194, down 8.3% from a decade earlier, according to Cushman & Wakefield.
“Most of our clients are trying to hit 100 to 140 SF per employee,” Sargent said. “Corporations are really focused on how to make the best use of their real estate, and in some cases, that means not having as much anymore.”
Sargent said many of her clients realized their footprint was underutilized by as much as 50% after the recession.
“Which means we are underleveraging that asset,” she added.
The debate currently happening is over how much more companies can cram their workers together.
“I would say 180 [SF per person] is probably sort of the sweet spot for an average,” Colliers’ researcher Newbold said. “It’s hard to say how low can it go, where it will bottom out. I just don’t think right now you can put a bottom on it.”
Other commercial real estate executives said that companies will be willing to shrink their footprints much more. While coworking and flex office have boomed in the past decade, so have the complaints by employees over lack of privacy and an increase in distractions.
“I don’t think [companies] can get a lot denser without creating problems. That gives me a little bit of comfort as a landlord. We’re not going to wake up one day and everybody is working from home,” Highwoods Properties Vice President Jim Bacchetta said. “I talk to CEOs who wish they never allowed telecommuting because they see signs of reduced efficiency, reduced productivity. They lose something in their company culture. There’s a lack of trust. They lose that personal connection with their fellow workers.”
As per-employee space shrinks, it allows companies — especially law firms and other professions that historically have given even midlevel workers private offices — to spend on trophy office space and still save money when they leave their old, inefficient workspaces.
Transwestern’s Dean recently toured a host of Class-B office towers in New York City for a client and noted how expensive it was going to be to transform the spaces into what his client wanted. The floors were dotted with pillars and smaller than modern office skyscrapers developers are building on Manhattan’s West Side — where tenants like Facebook, Google and Amazon have all signed major leases this year.
“It’s a mess. If they weren’t in New York, they wouldn’t be desirable,” Dean said. “I would be worried if I were those [landlords]. You’re going to have a problem to attract companies who rely on talent for their business. Because this is a talent game.”
What Talent Wants
Office space still fills an intrinsic human need: the need for community and interaction. Even with the growth in the gig economy, people will still want to gather around others.
“Again, they may not be working for a corporation that has traditional office space. But they are also not likely working in the 1970s couch in the basement,” Dean said. “People want to be around other people. Even if they’re not collaborating with them, it’s a human need.”
The total freelance workforce today is estimated to be approaching 60 million people, according to Upwork. Corporate America spends about $864B annually on gig work, according to Staffing Industry Analysts. Freelance and gig workers rarely go into an office. When companies use those workers, and encourage employees to telework, their real estate costs drop to zero.
“The cost of their individual occupancy is being shoved upon the individual worker,” Dean said.
While data is hard to come by, an inspection of Internal Revenue Service data from 2003 to 2017 shows an increase in the number of taxpayers who were claiming deductions for home offices. Even with a slight decrease during the Great Recession, the number of taxpayers claiming the deduction jumped nearly 45%, from 2.75 million to 3.98 million between 2003 and 2017. But there is likely a ceiling by which workers will accept those costs, Sargent said.
“Go look at a Starbucks or Panera any day at 11. I bet 90% of the tables are being taken up [by gig workers],” Sargent said. “It’s why there are people working at Panera, because there are a whole lot of [companies] who aren’t willing to pay.”
That could mean businesses will eventually hit a wall when it comes to the shrinking office.
“I mean, individuals can’t bear the cost of that,” Sargent said. “I absolutely think that companies are looking to shed the responsibility of having to provide everything for them. But that comes at a cost. You’re going to have to pay for [space] for gig workers. What gig workers are getting paid, that rate will have to go up.”
Even with its growing reliance on contract workers, Morris said EY sees providing a space for people to work as a means to an end, a way to keep their contractors happy and coming back.
“At the end of the day, if we don’t attract the best and the brightest talent, we’re not competitive anymore,” he said. “If you want that gig worker to come back and work for you if you haven’t created that right work environment for them, they’re not coming back to work for you.”
Ultimately, Sargent said it will be up to the company to hone a corporate culture that will keep workers — whether freelancers or permanent employees — loyal.
“Space has an impact and it can absolutely be a differentiator,” she said. “But it’s not the biggest differentiator, to be brutally honest. If you have a broken culture, if you have a toxic work environment, the most gorgeous space on the planet isn’t going to do it.”
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