MAGAZINE: A difficult new world

Working from the office in the US has lost its appeal for many, leading to questions over the future of the asset class. Robin Marriott reports. (long form article)

In real estate it is often said that what one sees in the US is a precursor to what’s coming in Europe.

Over the cycles, this has often proved right. Sometimes, it is to do with how the psyche of US business leads to quick acceptance of pain followed by recovery. Later, Europe catches up. Yet, there is a big new real estate story that is unfolding in the US that might yet prove an exception.

The latest data suggests that US workers are spending less time Working From Office (WFO) than their counterparts in Europe. The average occupancy level in 10 top US cities is 49.9% according to Kastle Systems, which uses keycard, fob, and app access data to determine weekly office tenant occupancy rates. This compares with an average occupancy level in key European cities of 55%, according to Savills.

But unlike other US stories, Europe is not predicted to follow the US in lower WFO or occupancy levels. But why the difference?

‘That is the million-dollar question,’ says London-based Victoria Mejevitch, head of global benchmarking services at JLL.

Why US workers are spending less time Working From Office does not have a scientific answer. But the data suggests in the US it is 2.4 days a week. In France, it is 3.1 days, in Switzerland 2.8 and in the UK 2.6. But just as interesting as the US-Europe divide are differences between European countries. Germany, for example, has the lowest WFO rate at 2 days.

Though there are no empirically proven reasons, many people have their own theories to explain the differences.

On a recent business trip to Vienna in March, the author met a real estate company executive working downtown who said offices in the Austrian capital were busy. He said travel to and from office locations in Vienna was relatively simple and quick in this city. And those living in apartments are choosing to come into the office.

JLL’s Mejevitch says: ‘I think differences are a lot to do with the length of commute, and the office location. The worst attendance in the US is for offices in business parks in the middle of nowhere and the availability of space at home – enough space for the home office.’

It’s an important thing for companies and landlords to understand.

For landlords, they need to know what their customers need, and companies meanwhile are concerned because links have been made between days in the office and productivity. In March, global asset manager, DWS, said in a research paper about sustainable next-generation offices: ‘Research indicates that productivity increases when working from home for 1-2 days a week, but strongly decreases thereafter, making the case for hybrid working models with different layouts, including more collaborative spaces and meeting rooms.’

‘Covid-19 already led to changes in occupancy rates and office reconfiguration. After government-imposed restrictions were lifted, occupancy rates started to recover, but remain below pre-Covid levels.’

Silicon Valley slump
As of May, the average occupancy level among 10 major US cities remains below most of Europe.

According to Kastle Systems, Austin in Texas has the highest occupancy level at 68.1%, while San Jose – ‘the capital of Silicon Valley’ - has the lowest at 40.6%.

And, a recent report by Savills also backed up the identification of San Francisco and the South Bay area as having the lowest office vacancy rates.

‘With economic uncertainty, slow return-to-office utilisation, and an ongoing correction in the technology sector, it is no surprise that the San Francisco office market has gone from having the lowest availability levels in the country pre-pandemic to having the highest availability levels in just over three years,’ Savills stated in its report.

Numerous local news outlets picked up on the story such as the Mercury News, which said: ‘Office vacancy rates have increased in the South Bay and have ballooned to brutal levels in San Francisco amid a wobbly economy jolted by wide-ranging job cuts in the tech and biotech sectors.’

‘Silicon Valley’s office vacancy rate increased to 23.1% in the first quarter of 2023, a level that Savills described as a new historical high, and up from 22.7% in the final three months of 2022.’

Asking office rents in San Francisco, on a monthly basis, averaged $5.89 per square foot in the January-through-March quarter of 2023, down from $5.94 per square foot in Q4 2022. ‘We expect office availability (in San Francisco) to continue to increase in 2023 as the slowdown in the technology sector persists,’ Savills said in the report.

Cresa, another real estate advisory firm, said in a report that a lot of layoffs had taken place in Silicon Valley. Bob Badagliacco, senior vice president in Cresa’s Silicon Valley office told news outlets: ‘With the macroeconomic headwinds that hit the economy last year, and a lot of layoffs and things like that, the road ahead for the office market in Silicon Valley - albeit perhaps not as bleak as in urban markets - is still going to be a challenging couple of years. Most of my office client base is looking to get rid of space, not secure new space.’

Leaving the big city
In New York, the average occupancy level is 48.4%. This is a city that some young workers have decided to leave in order to return to their hometowns.

Josh Nowak is just one of many examples. He is a freelance video production worker who moved back to his home state of Ohio.

He says: ‘I moved from NYC back to Columbus, Ohio, about a year ago. The cost of living wasn't necessarily the issue for me; it was just the desire to have a larger living space and to be closer to my family.’

‘Columbus is also experiencing quite a boom right now; it’s supposedly on track to eclipse Chicago’s population and be the largest city in the Midwest in about a decade or so. That’s primarily due to many tech companies coming here, like Intel. All that aside, I travel quite a bit for my work directing/shooting commercials and movies, so I rarely work in the city I live in.’

Asked if he felt office occupancy levels were falling in the US, he adds: ‘I don't doubt it. The above is just my experience. We may be entering a recessionary period globally, or we may be already in one. I know many people in the US are now considered "gig workers" or freelancers. I would be included in that. I was hired for a two-month contract, and when it's up, I go on to the next project with whoever will hire me. But I feel fortunate and grateful to make a steady income. I know some are less fortunate.’

In the US, the linked point people make is an obvious one. That if people live in the suburbs and are not travelling into the centre so much, then the ‘burbs are ‘thriving’. Some might be moving from centre locations to these fringes. This has been dubbed the donut effect. The suggestion is this has been seen most notably in New York and San Francisco.

There are clearly nuances in the US office markets, as Troy Javaher, head of Europe at Lincoln Property Group, notes. He experiences this first hand when visiting his employer’s HQ at Dallas, Texas, as well as other US metropolises and European cities. ‘There are certainly the well-identified differences between the US and the European/UK office markets,’ he says. ‘The different leasing characteristics, the greater dependency on tech occupiers and the much greater supply of dated, commoditised (particularly suburban) offices are definitely adversely impacting the US more than they are on this side of the Atlantic.’

He adds: ‘And then there are the geographical comparisons even within the US, such as the differences in occupancy between the coastal gateway cities and those of the Sunbelt markets.’

Pick-up imminent?
JLL’s Mejevitch notes how since the beginning of this year, more organisations have mandated - or will be mandating from the autumn - a certain percentage of time in the office for their employees. Examples include: Amazon 3 days, JP Morgan 4 days, and Blackrock 4 days.

Mejevitch draws attention to the Kastle barometer, which suggests office utilisation is creeping up in the US. For example, in Dallas, Texas, levels have risen from 51.9% to 53.8% of late, and rises have also been seen in Austin, Houston, and New York (see chart). But then again, declines have been observed in LA, San Jose, Chicago, Philadelphia, San Francisco, and Washington DC.

Mejevitch observes: ‘Technology companies have worse attendance than other industries. It seems technology and financial services are on the opposite sides of the spectrum.

‘Regarding the human experience in offices, people who work in a hybrid way and are in the office 3-4 days a week seem to be the most stressed.’

But what does the US occupancy malaise mean to real estate office owners?

In the US, the Nareit T-Tracker measures the overall performance quarter by quarter of what it calls ‘the heartbeat’ of the US listed REIT sector. Its data for the fourth quarter of 2022 underlined that office occupancy is lagging other property sectors – putting the figure at 89.3%. Yet the organisation said performance looked okay. ‘Despite slow returns to the office, office REITs displayed considerable operational strength. In aggregate, office REITs posted annual funds from operations of $7.3 bn in 2022, a 4.9% increase over the prior year.’

But no-one knows where US office REITs are headed.

Nareit said: ‘Office real estate is at the centre of a natural workplace experiment, and 2023 is marking a new phase in this experiment. We likely won’t know the future of offices for at least a few more quarters or years.’

Already the signs do not look great. In May, reports said cash flows have begun to erode as more tenants downsize amid hybrid practices.

However, Lincoln’s Javaher has a positive message for the market. ‘There are differences, but also the similarities of what is working are also clearly identifiable and applicable to both sides of the Atlantic. Both US and European markets exhibit the increasing polarization between the “best and the rest” and both will require a significant rethink into how to viably repurpose a massive proportion of the functionally obsolete space.’

‘Nonetheless, there is very solid demand for the excellent, sustainable buildings in the best locations which offer exceptional amenities in a proper, walkable mixed-use environment.’

‘Compelling people back to the offices won’t work, but creating compelling spaces will, which in turn drives compelling rents.’

Which for real estate professionals, is what it is all about.


Mind the gap

CBRE has suggested some distressed sales of US office could materialise due to what it calls a ‘debt funding gap’. 

In a paper published in December, CBRE said a funding gap exists when investors are forced to refinance at a loan-to-value ratio lower than at which they first borrowed or when the value had fallen since the original valuation.

Between 2023 and 2025, the firm’s Econometric Advisors team calculate a $52.9 bn (€48.7 bn) gap is likely to lead to distress for some investors, while others are forced to inject more cash into their properties. (see graphic accompanying this article)

Case study

To understand the debt funding gap, CBRE says consider a theoretical office building worth $100 mln in 2019. By 2024, it expects the value of the property to have fallen by 15% to $85 mln. With a constant LTV of 72%, the property owner could expect to borrow $61.2 mln against it. So far, this would create a debt funding gap of ($72 – $61.2) $10.8 mln. However, once the lower LTV of 57% is used, the property owner can only borrow $48.4 mln. Together, the combination of expected value decline and lending conditions means this building will experience a debt funding gap of $23.6 mln by 2024 ($72 – $48.4). This means that a capital structure that initially consisted of $28 mln of equity (72% LTV) will have to find a way to nearly double the equity in the asset. Borrowers facing a potential refinancing gap may pursue additional equity or mezzanine financing to pay off the existing loan. In addition, they may negotiate a discounted payoff with the lender, or an extension of the loan term if property income conditions are likely to improve. Ultimately, some borrowers may be forced to default.


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