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The growth of hybrid and remote work environments remain a threat to office occupancy.

The term “Return to The Office” has commanded time in the news cycle over the past two and a half years. As companies struggle through return strategies, executives are realizing there is no one-size-fits all solution to the future of the office. Despite the uncertainty, investors and tenants are similar in their attraction to quality.

The office sector is enduring a period of change driven by COVID-19. As work continues to fluctuate between offsite and onsite, one thing is clear: many workers have returned to the office, at least on a hybrid schedule.

On average, office occupancy continues hovering below 50% – according to Kastle’s 10-city Back to Work Barometer – this week at 47.6%.

Source: Kastle

Specific markets have been more successful at coaxing employees back into the office. Texas cities such as Austin, Dallas, and Houston, have seen occupancy levels averaging 57%. Recall, Texas was one of the first states to ease COVID rules and restrictions in March of 2021.

Hybrid work is stabilizing as we consistently see higher occupancy rates on Tuesdays and Wednesdays, ~55%, compared to a low on Fridays, ~32%.

Source: Kastle

Executives are balancing their desire for personnel to return to the office with employee retention and labor market constraint dynamics. Therefore, many have allowed for a hybrid and remote work environment.

Offices are a place for employees to collaborate, host clients, and exemplify company culture. To pull employees back to the office, companies are developing collaborative and creative spaces.

The market has shifted to quality as a primary driver of leasing decisions. Tenants are downsizing and relocating into Class A space while investing in footprint adjustments. Demand for properties built after 2015 increased even as demand in the broader office market fell. Flight to quality has led to nearly 90 million square feet of positive net absorption in new vintage.1

Source: JLL Research

Leasing activity by building vintage suggests newer properties will extend their lead in coming quarters. Over the past year, leasing activity as a share of inventory overall averaged 3.2%. But it’s twice that — 6.4% — for office properties built since the beginning of 2010. The spread is even wider in some markets with the most active leasing activity. In Boston, leasing as a percent of inventory among newer properties is almost 17%, compared to 5% across all building vintages.2

Investors are also eying quality when acquiring properties. There is still a demand for well-leased, Class A assets with sustainable features and modern amenities among investors. Investors are seeing higher rent growth in Class A buildings compared to Class B/C buildings.

Annual Effective Rent Growth by Type

Source: CBRE Research, Q2 2022

CBRE’s analysis of more than 2,700 lease comps across 12 U.S. office markets from 2019 to Q2 2022 shows the effective rents for top-tier (Class A assets) increased by 3.8% in 2021 and by 6.7% through Q2 of this year. Conversely, effective rents for lower-tier (Class B/C assets) buildings fell by 3.4% in 2021 and by 1.1% so far this year.3

As the economy moves in a recessionary direction and COVID-19 becomes less of a worry, the future of the office market remains unknown. However, flight to quality, with sustainable features and modern amenities, remains an overarching theme which seems here to stay for both tenants and investors.

 

Sources:

1 JLL – JLL | Q3 2022 US Office Outlook

2 Costar –  As the Role of the Office Evolves, Bigger Is Not Always Better (costar.com)

3 CBRE – Flight-to-Quality Trend Apparent as Top-Tier Office Assets Outperform | CBRE

   Kastle – Kastle Systems – Data Assisting in Return to Office Plans

 

The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance.  The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.

 

Colleen Quinn

Assistant Vice President, Asset Management
Boyd Watterson Asset Management, LLC

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