Lessons from the Past for Office’s “New Normal”

The following column is from Andreas Mathenywho is Dallas Research Manager for Transwestern, a GlobeSt.com thought leader. The views expressed are the author’s own.

For many months the national narrative was not friendly to the office sector. Empty neighborhoods and rosy assessments of remote work have made it difficult for companies to lure workers back into the office. In debates, the value of office is often all or nothing, and that’s a short-sighted perspective. In fact, companies are returning to a central purpose of the office: to create a place where individual lived experiences are synthesized into novel solutions that bring greater value to us and society at large.

However, not every city is on the same path to economic recovery, and businesses need flexibility to recruit and retain talent. Office operators and investors must also become more flexible in their way of doing business.

DALLAS DEFIES THE NARRATIVE

Dallas has been a leader in office recovery, improving office fundamentals from the pandemic faster than peer cities and Creation of jobs at an above-average rate. It also counts as Top market for international investors. Its success transcends Sunbelt’s overall outperformance or its earlier reopening than New York or Chicago. Rather, there are some themes that underpin attitudes and behaviors that could be beneficial to other markets.

Escape to quality is key. In Dallas, the biggest shift has been an acceleration of this trend beyond the usual suspects – more value-driven Class B office tenants are re-evaluating the desirability of their spaces to lure employees back into the office. The flight to quality has fueled demand for new housing even as vacancy rates in the market are rising, leading to urban buildings in Dallas Rental in record time.

Office footprints are restored. Before the pandemic, companies were downsizing their office space, reducing the amount of space per employee. Some argue remote work will further reduce the footprint. In contrast, Dallas renters strive for a highly amenified experience for employees, which leads to this No change to footprints or even growth as soon as future settings are included in the room plans. Gateway markets with denser floorplans (90-175 square feet per employee) will experience similar dynamics, even with a higher proportion of employees working from home.

Long-term leases are important in an inflationary environment. Companies have continued to sign long-term leases to offset rising space costs with better concession packages. In Dallas, the average lease term remains just over seven years; Tenants pay higher effective rents but get higher allowances for tenant improvements to build the kind of spaces that attract talent. Partial conversions are the future. Dallas saw it Office buildings complement different uses. While some office buildings are being fully converted into multifamily or hospitality, we believe that partial conversions will become more common and will create an attractive mixed-use office, residential and hospitality experience.

HISTORY DOES NOT REPEAT ITSELF, BUT OFTEN RHYMES

In the 1980s, economic growth from migration, rising oil prices, and a booming energy sector led to an unprecedented volume of office construction in Dallas, with office stock increasing over 100% Between 1982 and 1988 the office stock in Dallas increased over 100%. The real estate boom ended with the oil crisis and other shocks, causing office vacancies to peak at almost 30%. It took a decade for vacancy rates in Dallas to come close to equilibrium again.

The reality check of the 1980s taught Texas – and the country – many lessons. It taught us to look beyond technical analysis and focus on niches and groups of properties that the market deemed competitive. It taught us that inherent attributes are key to creating an experience that attracts demand – ultimately determining which properties have been successful and which have struggled.

Expressed in a simple way, quality was key to office performance when there was far more supply than tenants could absorb.

There are parallels between past and present. The most obvious is how the pandemic caused a shock to office demand and with it a rapid shift in the relative balance of supply and demand in both Texas and gateway markets. From this perspective, we see two distinct but equally important influences on the future of the office: (1) how office occupants are adapting to the post-pandemic norm, and (2) how the Think of office investors and other stakeholders are adapting to these new realities.

Part 1 will be written in the next 10 years. But part 2 – like us think about office space – is probably more urgent. Real estate decisions that follow the old paradigm are unlikely to succeed in the so-called “new normal.” Equally important, office investments can still provide excellent opportunities to create value and deliver superior returns to stakeholders.

Flexibility and innovation must guide the way we think about real estate so that it continues to offer the greatest possible value for all stakeholders. As CEO Larry Heard told the Transwestern team, despite the challenges of the past two years, complacency is not an option.

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