How Employee Preferences Are Impacting Commercial Real Estate

By KIMBERLEY HAAS

Remote work is being blamed for empty downtowns and looming bank failures but commercial real estate experts say the reality is employers are looking to lease the highest quality office spaces – leaving less desirable locations vacant – because that is what employees want.

In March, Federal Reserve Chair Jerome Powell said because of the shift to remote work, he expects some smaller and medium-sized banks to fail due to their exposure to the commercial real estate sector. He was speaking before the Senate Banking Committee during a hearing on the Fed’s monetary policy.

“In many cities, the downtown office district is very underpopulated. There are empty buildings in many major and minor cities. It also means that all the retail that was there to serve those thousands and thousands of people who work in those buildings, they’re under pressure, too,” Powell said, according to The Hill.

Powell reportedly expressed confidence that the Fed and financial regulators would be able to contain the fallout and prevent a broader crisis, saying they are having conversations with the banks most at risk.

So what is happening in the office market?

According to Richard Barkham, global chief economist for CBRE, the office sector is stabilizing and the retail market is also stable. He spoke during a midyear economic presentation at the National Association of Real Estate Editors conference in June.

“Defaults are increasing but there’s no widespread fire sale of commercial real estate taking place at all,” Barkham said.

Barkham added that bigger banks are provisioning heavily to set up a buffer for when CRE losses become problematic, if that happens.

“It may well be that those real estate losses get realized in the smaller banks and the regional banks. You’ll still expect 300 to 400 banks to fail, but they’re not failing, they’ll be consolidated into the larger banks and the larger banks are building up a buffer to be able to do that,” Barkham said.

Barkham said that right now they are seeing the same number of deals being made in the office sector as there were in 2019 but companies are taking only 60% to 70% of the space they leased five years ago. Part of that is being driven by employees’ desire to work in modern environments when in person and to use technology to work from home.

“What they’re gravitating towards is the modern construction, the post-2010 construction. The newer quality buildings, the better-amenitized buildings,” Barkham said. “Businesses are gravitating towards better quality space because they need to provide a better environment to get their workforce. That’s what their current expectation is.”

This is called “flight to quality.”

Alex Hancock, senior vice president of national sales and leasing at Howard Hughes Holdings, talked about “flight to quality” as he spoke during a panel discussion on remote work and the state of America’s office market at NAREE’s conference.

“That’s quality location, quality amenities, quality landlords, as well as quality buildings,” Hancock said.

Brett Merz, senior vice president of asset management at KBS Realty Advisors, said this presents an opportunity for owners of less desirable buildings if they are willing to renovate and improve their spaces to attract tenants.

“Flight to quality, it’s real. It’s not necessarily a new concept but I do believe it has momentum and it keeps going further,” Merz said. “If you look at some of the submarkets that we’re in, it can be as much as a 6% difference in vacancy between a Tier 1 asset or a non-Tier 1 asset.”

According to CBRE, prime buildings had a positive net absorption of 49 million square feet from Q1 2020 to Q1 2024, while non-prime buildings had a negative net absorption of 170 million square feet.

The latest Workforce Monitor survey commissioned by the American Staffing Association and conducted online by The Harris Poll found that 68% of Americans prefer a hybrid or in-person work schedule, highlighting the continued need for office space. Nearly 32% preferred a fully remote schedule, highlighting the need for technology in office and work-from-home settings.

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