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The pandemic sent everyone home from the office—and most employees still haven’t returned. More than two years after the initial lockdown, only 44% of workers are back in the office full-time, and 53% of companies are offering remote work at least one day per week. Without question, there has been a fundamental shift in office usage, and yet, traditional workplaces remain a vital component of corporate strategy.
Companies are looking for the office to play a new role in the employee experience. Rather than a place for head-down, individual work, the office is reemerging as a center for collaboration, socialization, and wellness. It's a space to foster company culture and support workers. As companies reevaluate and reformulate workplace strategies, many seek space in new office developments that better align with today's work models.
Remote work is not quite an accurate descriptor for the vast majority of employee workplace habits today. While most staffers in the U.S. have the option to work from home, only about one-third of employees never go into the office. Companies are investing in class-A, trophy properties outfitted with the latest technology and amenities to accommodate the majority of employees that move fluidly between the residence and the workplace. According to JLL’s 2022 Future of Work Survey, 77% of companies have prioritized investing in quality workspaces.
These top-tier properties have high-end designs, communal workspaces, hotel-like amenities, and more often than not, they are brand-new buildings. Developers launching new office projects in today's market have been in a unique position to build a new set of expectations, and they're delivering spaces that meet the need for new corporate needs for modern work models.
Quality offices have played a critical role in workplace strategy for the last decade to attract top professional talent, but today the workplace is also aiding employee retention. Because remote staffers can be poached by competitors near and far, employers need to make their facilities more appealing. That means providing space for them to work in groups, build trust, and enjoy onsite perks that support optimal performance.
New Developments Outperform Incumbents
The flight-to-quality trend is already manifesting in the data. Last year, general office statistics showed declining rents and leasing activity, but when segmenting the market by asset quality, a very different trend emerged.
Effective rents for the lowest-quality assets declined by 1.1% last year and 3.4% the year prior. However, effective rents for the highest quality assets increased by 6.7% in 2022 and 3.8% in 2021, according to a brief from CBRE that analyzed the country's 12 leading office markets. JLL researchers found a wide performance spread between newly built projects and existing properties, noting "pockets of outperformance remain as flight-to-quality creates a robust occupier market for new space."
The disparity in rents is a sign that companies are flocking to new and high-quality office developments, buoying rents in the upper segment of the market. Growing leasing activity is another sign of the demand for new office product. Last year, more than 104 million square feet of new office space were under construction. More than two-thirds is already pre-leased, and there have been 1.7 million square feet of positive absorption.
While that happened, gross leasing activity declined, and the sublease supply swelled to record levels. As companies downsize to adapt to remote work, many are relocating to higher-quality buildings. Overall, the flight-to-quality has driven leasing transactions, and the pre-leasing activity specifically reflects the growing occupier appetite for new, high-end workplaces.
Office Construction Pipeline Is Shrinking
Although new office development benefits from the remote work trend, the overall downward trajectory of the office market has given developers pause. As a result, the office real estate construction pipeline is shrinking. Through the end of the third quarter of 2022, only about 38 million square feet of new office inventory was delivered in the U.S., compared to 60 million square feet in 2021. The current pipeline of 104 million square feet represents a slight contraction of construction activity, with the majority of properties scheduled for delivery this year.
As a new product is delivered, experts believe the office vacancy rate will climb through 2023. Ground-up construction activity is expected to taper, even as the flight-to-quality gains momentum. The trend could drive increased rent appreciation, ramp up new property leasing volume, and prompt owners to launch extensive capital improvement plans to better compete with new facilities.
Developers Uncover Opportunities
As office tenants show an increasing preference for trophy assets, there's an opportunity for developers to pursue redevelopment projects to meet the market demand. As Mike Watts, president of CBRE's investor leasing for the Americas, explains, "Owners are investing more in their buildings to get into the top tier and stay in it." Landlords that don't change with the times risk losing their property altogether.
The widespread adoption of remote work has saddled much of the country with obsolete office spaces, and some state and local governments are urging developers to repurpose unused facilities into housing. California, for example, passed adaptive reuse legislation last month, providing $400 million to convert office buildings into affordable and workforce housing projects. Analysts at PwC expect that 10 to 20% of the current office supply will be repurposed, but the remainder must evolve to meet current tenant needs. That spells a lot of opportunity for office developers.
Investors have already started to take advantage of budding opportunities. New York City office investments increased 11% in the first half of 2022, showing that investors see a clear future for the role of the traditional workplace. Make no mistake, though; the market is still clouded with uncertainty.
Predictive technology will be essential to making these deals work as developers and investors step up to give existing stock a facelift. A.I.-powered analytics platforms can balance construction costs with the inherent risk associated with office projects in the current landscape. Tools like Northspyre help owners make informed and data-backed decisions that produce predictable outcomes, reduce overages, trim budgets, and keep schedules on track. For deals with thin margins and high risk, the benefits of these platforms are paramount to success.
Some developers are struggling to find their place in an office market that seemingly changed overnight. But leaders who had the foresight to embrace new work models addressed the paradigm shift last year are reaping big rewards. As the post-pandemic office sector comes into focus, real estate teams will need to become better informed and decisive to capitalize on tomorrow's most significant opportunities.
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Tag(s): Real Estate Development
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