After pandemic, shrinking need for office space could crush landlords
By Peter Eavis and Matthew Haag
As office vacancies climb to their highest levels in decades with businesses giving up office space and embracing remote work, the real estate industry in many American cities faces a potentially grave threat.
Businesses have discovered during the pandemic that they could function with nearly all of their workers out of the office, an arrangement many intend to continue in some form. That could wallop the big property companies that build and own office buildings — and lead to a sharp pullback in construction, steep drops in office rents, fewer people frequenting restaurants and stores, and potentially perilous declines in the tax revenue of city governments and school districts.
In only a year, the market value of office towers in Manhattan, home to the country’s two largest central business districts, has plummeted 25%, according to city projections released Wednesday, contributing to an estimated $1 billion drop in property tax revenue.
JPMorgan Chase, Ford Motor, Salesforce, Target and more are giving up expensive office space, and others are considering doing so. Jamie Dimon, chief executive of JPMorgan Chase, the largest private sector employer in New York City, wrote in a letter to shareholders this week that remote work would “significantly reduce our need for real estate.” For every 100 employees, he said, his bank “may need seats for only 60 on average.”
And just as Coca-Cola’s profits would take a seismic hit if consumers abruptly cut back on sodas, owners of office buildings, many of which are owned by pension funds, insurance companies, individuals and other investors, could be pummeled if many businesses rent less space. “The pandemic has proven that work from home is viable,” said Jonathan Litt, chief investment officer of Land & Buildings, a real estate investment firm that has taken a bearish view of the New York office market. “It’s not going away; businesses are going to adjust, and office real estate is going to take it on the chin during that adjustment period.”
Across the country, the vacancy rate for office buildings in city centers has steadily climbed over the past year to reach 16.4%, according to Cushman & Wakefield, the highest in about a decade. That number could climb further, even as vaccinations allow some people to go back to work, if companies keep giving up office space because of hybrid or fully remote work.
So far, landlords like Boston Properties and SL Green have not suffered huge financial losses, having survived the past year by collecting rent from tenants locked into long leases — the average contract for office space runs about seven years.
But as leases slowly come up for renewal, property owners could be left with scores of empty floors. At the same time, many new office buildings are under construction — 124 million square feet nationwide, or enough for roughly 700,000 workers. Those changes could drive down rents, which were touching new highs before the pandemic. And rents help determine assessments that are the basis for property tax bills.
Many big employers have already given notice to the owners of some prestigious buildings that they are leaving when their leases end. United Airlines is giving up some 150,000 square feet, or over 17% of its space, at Willis Tower in Chicago, the third tallest building in the country and a prized possession of Blackstone, the Wall Street firm. Salesforce is subletting half its space, equivalent to roughly 225,000 square feet, at 350 Mission St., a San Francisco tower designed by Skidmore, Owings & Merrill and owned by Kilroy Realty.
Roughly 17.3% of all office space in Manhattan is available for lease, the highest proportion in at least three decades. Asking rents on the island have dropped to just over $74 a square foot, from nearly $82 at the beginning of 2020, according to a recent report by the real estate services company Newmark. Elsewhere, asking rents have largely stayed flat from a year ago, including in Boston and Houston, but have climbed slightly in Chicago.
The stock prices of the big landlords, which are often structured as real estate investment trusts that pass almost all of their profit to investors, trade well below their previous highs, even as the wider stock market and some companies in other industries like airlines and hotels that were hit hard by the pandemic have hit new highs. Shares of Boston Properties, one of the largest office landlords, are down 29% from the prepandemic high. SL Green, a major New York landlord, is 26% lower.
Fitch Ratings estimated that office landlords’ profits would fall 15% if companies allowed workers to be at home just 1 1/2 days a week on average. Three days at home could slash income by 30%.
Senior executives at property companies claim not to be worried. They argue that working from home will quickly fade once most of the country is vaccinated. Their reasons to think this? They say many corporate executives have told them that it is hard to effectively get workers to collaborate or train young professionals when they are not together.
Large tech companies, including Amazon, Facebook, Google and Apple, have added office space in New York City during the pandemic, and some of them are planning expansions elsewhere. Last week, Amazon told employees it would “return to an office-centric culture as our baseline.”
“Companies that work in person are going to be more successful going forward than those that work virtually,” Owen Thomas, chief executive of Boston Properties, said in an interview.
The recession caused by the pandemic is different from past ones in an important way that could benefit landlords. After the financial crisis, banks, insurance companies, investment firms and other such businesses shed some 600,000 employees. But now companies that employ lots of office workers have been relatively unscathed. “Our customers are doing well — most of them are not experiencing a recession,” Thomas said.
Predictions of a return to offices have often come up empty. A year ago, many real estate executives said that state-imposed lockdowns would be relaxed by the summer. A year later, many states have eased restrictions and roughly 3 million Americans are getting vaccinated daily. Yet, on average, just a quarter of workers in the 10 biggest urban areas have returned to offices, a rate that has stayed mostly the same for months, according to Kastle Systems, a security company.
The cities with the lowest return rates are on the coasts, places like New York, San Francisco and Washington, Kastle said, where long commutes, often on dysfunctional transit systems, are common. Moody’s said in March that office landlords with many buildings in coastal cities would come under the most financial pressure in the coming years.
“We are just going to be bleeding lower for the next three to four years to find out what the new level of tenant demand is,” said Litt, the investor.