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While industry fundamentals are healthy and the economy is strong, the U.S. office sector faces pressures that could fundamentally alter its business model.
Jeff Adler and Jack Kern, vice president and director of institutional research, respectively, for Yardi Matrix, provided an update on a sector in transition in a recent webinar.
After a shaky fourth quarter of 2018, the U.S. economy has rebounded into “really good shape,” Adler said, with a rising stock market and inflation that is largely held in check by increased domestic oil production. The labor market is very tight—the best in 50 years, he said—with office-using sectors outpacing overall job and wage growth over the past five years and most markets absorbing available office space.
Metros such as Dallas, Houston and Atlanta are growing fast and adding office-using jobs. Other locations with job growth and low unemployment, such as Orlando, Fla., Nashville, Tenn., San Francisco and the nearby Bay Area, have to import workers to meet staffing needs. Most markets still have room to absorb office space. In short, the industry is in a good place, and if the federal government’s pro-growth policies outweigh its anti-growth ones, “the party goes on,” Adler said.
So what are the challenges? One of the main secular (long-term) factors is coworking, which pulls 1-3% of market demand from traditional office leases and keeps growing as companies expand beyond their primary locations. The practice is growing everywhere and won’t likely go away anytime soon, Adler said. Per-employee square footage is decreasing, particularly in central business districts and high-cost metros. With a tight labor market, companies are luring talent by making office “an experience-driven sector,” similar to what has happened in retail, incorporating design elements and attractions such as new technology, spaces for relaxation, natural light, day care facilities and configurable furniture into the work environment. Creating spaces with such attributes requires substantial capital expenditures.
In addition to coworking and the work-at-home population, which has risen 115% since 2005, office owners in gateway markets such as Los Angeles and New York City are grappling with a migration of talent to lower-cost tech hubs such as Raleigh, N.C., Orlando, Denver, Phoenix and Austin, Texas.
The coworking concept is expanding to areas not traditionally considered office environments, such as hotels, airports, multifamily communities and college campuses. One notable example of an integrated live/work/play space is The Domain in Austin, which integrates retail, restaurants, hotel space and apartments.
This shifting landscape also changes paradigms for brokers, who no longer merely buy and sell space but must also create value by delivering diversified real estate services, curating the experience and leveraging scale. Brokers and owners also must come to terms with technology’s impact on commercial real estate in utility optimization and other areas, Adler and Kern said.
Adler also noted that numerous loans coming due in markets with heavy development pipelines over the next two years. With only 20% of those loans being less than 10 years old, participating in revitalizing older stock presents a considerable number of value-add opportunities.
With conditions sufficient to maintain office-using employment growth, occupancy and slow rental growth, the office sector is in good shape, with entrepreneurial activity and “creating a place” among the key trends. Those seeking to create meaningful value in the sector should “think across assets classes and experiences,” Adler said.
Download the complete Yardi Matrix office market update presentation.
