Employees are Returning to the Workplace, But That Has Not Moved the Needle on New Office Development

Commercial real estate in California remains a positive place to be, despite concerns about vacancies and a potential recession. Developers are still finding opportunities for growth, a fact underscored by the more than four million square feet under construction in the greater Los Angeles area in the first quarter of 2022. CBRE president Lew Horne and Elizabeth Wilgenburg, a partner in the Century City office of Allen Matkins, shared their perspective on current market trends and how they are shaping California office development, as part of the Summer 2022 Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey.

Return to Office Continues

The same technology that made remote work possible during the pandemic is now revealing how important office culture is to corporations. As companies recognize the value of collaborating face to face and the limitations of connecting over a video call, they’re pulling people back into a traditional work environment. At the same time, employers are evaluating buildings with employee health and wellness in mind in the wake of the pandemic. They want to create working environments where employees and clients feel safe.

Because of this transition, tenants are paying more attention to the spaces they inhabit, including where they are located and how they can use them to attract and retain talent. They’re looking for ways to encourage workers to return to the office by providing them with amenities, technology, and work spaces they don’t have available at home. When evaluating buildings, they consider factors like walkability, bandwidth capabilities, nearby restaurants, and more.

Companies Want Flexible, Open Space

Although employees are returning to the office, they’re not returning to the same types of spaces they worked in before the pandemic. Tenants are looking for creative office space and adaptive repurposing that lets them design the space around the way they work. This is especially true for those who want to accommodate enhanced technology throughout the office. Companies are moving away from individual offices and desks and incorporating more flexible designs they can convert into workspaces and collaborative spaces as needed.

Despite some speculation that tenants would seek out more space to accommodate workers in the post-pandemic office environment, tenants are not necessarily seeking more space than they had before. In fact, the opposite may be true, according to Wilgenburg. Flexible space reduces the need for separate collaborative work areas and desk space. In some cases, companies are implementing a hybrid model or cutting back on positions, which reduces the number of workers in the building at a given time.

Location Still Matters

Commercial real estate activity is clustered, with some areas and industries seeing more development than others. Both Wilgenburg and Horne agree that one factor in this decision is commute time. Employees generally prefer to work close to where they live, and the markets with the longest commute time continue to lag behind other areas. For example, Long Beach, Hollywood, and the west side of Los Angeles are seeing activity — in part because they may be taking advantage of rent prices, but also because companies may be opening satellite offices closer to where people work.

Office Rates Will Likely Remain Flat for Now

Rising construction costs and general uncertainty about the market continue to influence tenants’ decision-making. High interest rates have increased the cost of borrowing money, leaving tenants to rely more on landlords to provide funding for these projects. As a result, rents are staying flat or going down as landlords absorb these costs without raising the rent. Those who refuse to provide tenants with the amenities and space they want will likely continue to see high vacancy rates.

This has been a shift for landlords in key areas where rents have been consistently low in the last decade. The low rents made it possible for owners to avoid spending large sums of money on the buildings. In the current environment, this is no longer feasible, as people would rather continue working from home than be forced to work in an outdated or poorly managed building. This will likely be a factor until the current economic trends play out.

Tenants Are Choosing Short-Term Leases

According to Wilgenburg, traditional long-term leases still exist, but they seem to be limited to bigger companies or industries like life science and entertainment studios for now. Tenants are more likely to opt for a short-term lease as they sort out how much space they need moving forward. Two and three-year lease agreements are more common than five or ten-year leases, and this trend should continue until companies have a better understanding of how their offices will function in a post-pandemic world.

These trends are, in large part, a continuation of what the analysts have noticed over the last couple of years. However, they underscore the health of the commercial real estate market in southern California. As Horne pointed out, it’s still one of the most dynamic markets in the world.