The Future of Office is Evolving

The COVID-19 pandemic has changed the way we work and is redefining the office, according to the Winter 2022 Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey. Overall, office development and rental occupancy rates should improve as developers begin accommodating the turns they see in the office market. Chris Roeder, Executive Managing Director at JLL, and Mike Kostecka, Real Estate Partner at Allen Matkins, offered insight into these office trends and what they expect to see in the market’s future.

1. Office is Not Dead

Workers proved that it is possible to work productively from home, raising questions about the viability of the central office. All indicators, however, show the reverse of this to be true. Companies have recognized the value of bringing their teams together in person. And those that have not already returned to the office will begin to do so, sometimes in phases.

Kostecka notes that much of the activity currently taking place in the market is confined to smaller tenants with under 10,000 square feet of space. Larger tenants are more likely to extend their leases as they wait to see how the long-term effects of COVID will affect their business. He adds that some developers are trying to convert existing office space to life science, but they face significant barriers, including the cost and difficulty of valuing life science companies outside the Fortune 500 list.

Roeder remains bullishly optimistic about the sector. Last year, he saw 27 transactions close for space greater than 50,000 square feet — nearly double the number of closings during the previous year. Leasing is up, and absorption levels have improved. He adds that an all-time high of venture capital is making it possible for well-located products to perform well and is encouraging conversions from office to life science.

2. Workers Will Return to the Office, But They May Not Go Back to the Same Space

The return to office will not necessarily be a return to a pre-pandemic work environment. Some companies will continue to give employees the flexibility to work remotely part-time. Others will opt for satellite offices to shorten commute times instead of requiring everyone to work in a single central office. These changes will force shifts in office design and layout, and existing office spaces will need to be remodeled to accommodate them.

Roeder is seeing a “huge flight to quality,” noting that companies are willing to pay more for new construction instead of dealing with the inventory of functionally obsolete real estate on the market. A recent JLL survey found that 58% of companies are changing their workplaces to create more collaborative spaces with more amenities for workers. At the same time, many of these companies are actively working to reduce their footprints.

According to Kostecka,  many companies are taking a “wait and see” approach before deciding what to do with their office space. Although he believes the transition to satellite offices is inevitable, he hasn’t noticed his clients opening any to date.

3. Life Science and Suburban Markets Are Hot

The life science and tech centers in southern California are booming, increasing the demand for office space in the area. It should be no surprise that respondents in San Diego report the greatest levels of optimism. In northern California, demand should grow as fast as supply, and more developers plan to start projects within the next year. Current projections show the office sector will be back on track by the end of 2024.

Kostecka and Roeder agree. According to Roeder, big tech is driving these markets — and will likely lead them back to urban centers. He expects proximity to public transportation to be an important differentiator, noting that companies in the suburbs have already started returning to office work. He’s quick to add that urban centers will come back.

Kostecka added that rents have increased in many suburban markets, including the Inland Empire and Conejo Valley, as well as in cities like Phoenix and Las Vegas. He points out that companies are following the workers who are moving to cities with a lower cost of living. High rents in urban areas, including San Francisco, are driving workers out of urban cores, and employers are following them.

Overall, the panelists are optimistic about rental and occupancy rates and expect them to improve. The exception to this is Sacramento because of the high demand for space by the state government. Businesses that have been able to pay rent during the pandemic are still doing well. Although the office market should be back on track by 2024, some areas may not see any significant development over the next two years.