What happens to all the empty office space?

There's a good chance we won't be returning to the office in anything close to the same numbers as we were before COVID-19.
Empty office space

Now that we have been dealing with the COVID-19 global pandemic for almost a year, we’re starting to see a disturbing office space usage pattern. This could have profound implications on commercial real estate values in the future. I don’t claim to be any kind of real estate expert, but logic, supply, and demand calculations tell us there is a serious future problem here.

Office space isn’t like oil or employment. While our energy use dropped dramatically during the pandemic and shutdown, oil demand fell just 15 percent at the lowest point, and it has since recovered to where it’s down about 6 percent – for now. But that’s a story for another day. Unemployment shot higher as we shut down the economy, exploding from 3.5 percent to almost 17 percent. As bad as that is, that also meant that more than 80 percent of the workforce remained employed.

However, office space usage dropped like a rock. While it has recovered a bit, it isn’t likely that this story has a happy ending. Commercial space giant CBRE Group estimates that national office vacancy rates were 13 percent during the second quarter of 2020, which was an increase of just 0.7 percent. But leasing rates actually went higher, with prices up 0.3 percent for the quarter and up 3.7 percent over the previous year. How could that be during such a crisis? Leases don’t describe usage. While an office may be leased, is the space full, half-full, or less?

CBRE’s figures describe leased space. Only a small fraction of national leases came up for renewal in the second quarter, so we don’t have a good gauge of how many companies currently leasing space would like to end or amend their contracts.

A better estimate of where we are and what likely lies ahead comes from Kastle Systems, which handles secure site access through key fobs and security cards for more than 3,500 buildings and 41,000 businesses across 47 states. In their latest report, Kastle shows that office use, compared with office space leased, is down significantly.

(Just anecdotally, how many businesses are you aware of where many of the employees are now working remotely? I can think of lots of them, and I’m sure you can too. Are they coming back to the office full time after this is all over? Probably not.)

The average use numbers across ten large metropolitan areas through the end of October (the latest numbers available) show that just 26.7 percent of employees are back at their desks. The highest use was in Dallas at 40.9 percent, and the lowest was in San Francisco at 14.5 percent.
That means there is a huge amount of unused space that somebody is paying for.

San Francisco is not only home to the U.S. technology sector, it also has the highest office rent prices in the nation. (Not to mention the insane political environment there. I know because I spent 17 years of my career there.) The news is full of stories of tech companies working with employees to keep offices shut through mid-2021 and even having employees permanently work remotely from lower-cost locations. The nation transitioned to widespread telecommuting out of necessity, but now many companies are making the move permanently by choice.

In the past, many thought working remotely could work, but most companies and many employees didn’t want to make an effort to try it. The pandemic forced it. Then they discovered that it could be done and actually worked pretty well for many businesses. And many of the staff, instead of dealing with outrageous traffic while commuting, and having to deal with outrageous cost of living challenges, could actually live almost anywhere and enjoy a higher standard of living with far less stress. I doubt many of them are in a hurry to get back to the old ways. However, this move will cost cities an almost unfathomable amount of money, and they know it.

As former office workers stay away, businesses near offices have less foot traffic. Retailers and restaurants suffer. Uber drivers have fewer passengers, parking garages house fewer cars, and public transportation carries fewer riders. Cities lose money every step of the way in the form of lost sales tax and less ridership revenue. At the end of the year, the problem will be lower property tax incomes as commercial building valuation assessments fall.

In a way, cities are like a business that must stay open, no matter what. They must provide essential services, no matter how many people show up. Sure, they can cut some marginal costs here and there. But their major costs are fixed, and large cities still have tremendous legacy costs, such as pensions.

These are the things that keep city councils and city managers up at night. Fortunately, Edmond has been in a pretty good situation through all of this, and our revenues have stayed steady. But the big cities in expensive areas are not worrying in silence. They’re frantically calling their Congresspersons, demanding bailouts from the federal government, because that’s the only pot of cash big enough to do the job. And who will pay for all that? You will.

The question for all of us is whether we think that’s a good use of our tax dollars. Cities aren’t airlines or restaurants. When the pandemic ends, we’ll be eating out again and jetting away as quickly as possible, eager to see anything but the insides of our homes. But there’s a really good chance we won’t be returning to the office in anything close to the same numbers as we were before COVID-19. With that in mind, we’d be better stewards of our tax dollars if we required major cities to present their plans for surviving not just the next 12 months, but also the next decade, with fewer commuters and lower tax receipts, before we send them bailout checks. Thanks for reading.

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About Nick Massey

Nick Massey is President of Massey Financial Services in Edmond, Oklahoma. Nick can be reached at www.nickmassey.com. Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.