While many highly qualified analysts have well-documented the transformation of the office sector, the question on many investors’ lips is: “Who are office tenants today, how can I reach them, and how can I benefit from taking advantage of current office market opportunities?”
Whether you’re a current owner uncertain about what to do with your office property, someone looking to buy at a discount, or a broker looking to advise your client with the best knowledge, this article un-fogs the murkiness of the sector. Here, we peer back into the history of the office sector to better inform today’s understanding of what tenants prioritize most in their office needs and the best strategies to meet that demand.
Painting the Scene: Offices from 2000-2020
The evolution of the office sector over the past few decades reveals significant shifts in design, tenant demographics, and market dynamics, driven by changing cultural norms and economic demands.
The 1980s era of the “Yuppie” office worker saw executives with offices as a status symbol emblematic of one’s power in an organization. From the mid-2000s until the pandemic, egalitarian practices started to become more popular, contributing to higher-density, open floor plans with five to six people per 1,000 square feet instead of the four per of previous years.
By the late 2010s, the office sector was experiencing a boom, with robust construction and heavy investment, particularly in major cities like NYC and San Francisco, who had 20 million square feet each in development by the end of the decade, and emerging markets like Miami and Austin. National office vacancies hit record lows at the end of 2019, as a diverse array of tenants – including legal services, banking groups, and tech companies – demanded spaces that could support their growth, resulting in many securing long-term leases of an average of five years with little negotiating power over the high rents.
However, these bustling office environments led to increased needs for amenities and infrastructure, such as enhanced parking facilities in cities with limited public transportation options like Nashville and Miami. Office buildings capitalized on this by integrating charges for parking spaces into their revenue streams. Amenities, too, became more desirable (though less of a necessity than they are today), such as proximity to food, shopping, and commuting centers, as well as fun perks like well-stocked kitchens and cold brew on tap.
The Pandemic Seismic Shift (or Hiccup)
And then came Covid. Different states and cities eased isolation restrictions at various points during the pandemic, but the brief isolation forever changed the country’s idea of the office.
The pandemic also accelerated trends budding before 2020, such as decentralization and harnessing technology to simplify and distribute workplace operations. Instead of opting for a single 40k square foot headquarters in one city, companies of different shapes and sizes saw the opportunities in talent acquisition and cost savings by, for example, dotting four smaller offices of 10k square foot, spread across the country. However, add in kitchens, copy rooms, and other common areas and these organizations ended up with a hypothetical 12k square feet per space: more than what they had utilized in their previous single headquarters.
Tools like Zoom and Slack made asynchronous work easy, and the pandemic only further popularized the “hub and spoke” model, especially as more workers fled larger cities for lower cost of living markets, accessible home prices, and larger living spaces – especially because their homes now served double-duty as their offices.
However, over the years of lockdown, many companies saw how remote work impacted spontaneous collaboration, networking opportunities, mentorship, and even worker mental health.
As such, many companies adapted their leasing needs to a key concept: flexibility.
So… Now What Are Tenants Doing?
Many small businesses are still working from home, but large companies started calling employees back to the office in 2022 and 2023, and many have implemented, at the very least, a hybrid model, if not a total return to the office. Nearly 80% of US workers are fully working in person, with the remaining amount either hybrid or fully remote. Regarding new leasing activity, however, some emerging trends have shifted post-COVID that will likely never revert to the mean.
As mentioned above, many corporate tenants are embracing smaller spaces with open floor plans in diverse markets for a spread-out footprint. This enables them to attract high-quality talent and not spend as much on rent in the highest markets, though optimizing the desirability of such spaces has become essential.
Amenities like restaurant proximity, high-end security systems, fast internet speeds, open courtyards, high-quality HVAC systems, natural greenery and lighting, and so on became part of the package to attract talent to a company, positioning Class A offices as the newly crowned king (and, indeed, the buoy overall) of the office sector. Commuting time also continues to be a high priority for office users, with the ideal distance of 20 minutes from the office playing a role in tenants’ decisions about where to set up shop.
While the demand for office space is, as ever, market-specific, it also depends on the tenant. Corporate tenants are coming back strong, able to mostly afford the high rent of these desirable, newer office developments. Conversely, many entrepreneurs, solo practitioners, or SMBs, who otherwise would have leased a smaller Class B or C space, are deciding they don’t need office space. It’s easier and more accepted than ever to start and run a small business from home and only rent a space when they reach that growth point.
Navigating the Negotiation Table
In a post-pandemic world, tenants have different things to consider when they come to the leasing table.
With fewer spaces leased in a building, higher common area maintenance (CAM) costs are worth considering. Many landlords have a standard pro rata agreement for tenants to cover CAM costs, but tenants want to avoid being responsible for picking up the slack if a building has empty space. Instead, tenants are having conversations about cap provisions to protect themselves from otherwise being liable for more than their fair share.
Tenants also have significant leverage in conversations with landlords and lease negotiations. TI allowances have become a valuable leverage point, where landlords can offer to reimburse costs or otherwise cover tenants to customize office suites to their needs. This is especially true in Class A buildings, especially those still finalizing development where upgrades can be incorporated into pre-leased corporate spaces. And in Class B buildings, the ability to beautify one’s space (not on one’s dollar) may make less-lovely buildings more viable for tenants seeking lower rents.
As such, office owners of desirable Class A buildings are able to demand higher rents, with corporate tenants ready to compete for such attractive spaces. Indeed, Class A asking prices and going rents have driven what small growth we’ve seen in the sector while Class B and C buildings continue to experience shrinking occupancy, and may even face demolition to make way for updated use.
The Bottom Line: What’s Next for the Office Sector?
So, one may ask what does an improving economy mean for the office sector? And given the thousands of layoffs (in part offset by strong hiring in some sectors) this year so far, particularly in the tech sector, how does this bode for office leasing?
Fortunately, from a supply/demand perspective, developers built little office space in the last five years. The market had a decent supply left from 2019 in specific markets, but because office construction was held in check, we expect an uptick in demand to occur gradually.
Class C offices are slowly being removed from the bucket altogether, with owners either selling for conversion projects or tearing down to make room for new assets – usually some kind of multifamily building (though this depends on zoning, market, floorplates, and feasibility). But overall, businesses are bouncing back, especially those proven through the pandemic, and growing – which means more jobs.
If you’re a current owner, I recommend a highly hands-on leasing approach with your tenants. Users have more leverage for now, and offices are not the passive source of income that NNN lease retail buildings are: owners should be aggressive and actively form relationships with their tenants, working closely with their broker to lock in long-standing lease agreements and consistent ROI.
As the evolving landscape of office space continues its pursuit of cyclical equilibrium, those who can best leverage data and optimize investment and leasing strategies will be best positioned for success. For those looking for even more insight into current markets, asset performance, and other data, Crexi Intelligence is your all-in-one tool for comprehensive commercial real estate insights.
Eli Randel is chief operating officer of CREXi, an online real estate research company.