Asset repurposing: Work from home, blessing or curse?

Continuing our research into asset repurposing, we are seeing many enter the short-term asset use space, with many targeting the capture of the millennial/digital nomad market via their own marketplaces. We have said for a while that Grade B + C asset owners are going to be the ones most impacted by the new working world. This is beginning to play out + recent zoning changes are making this easier in New York as an example...

COVID-19 led to drastic permanent changes in how we work and where we work. Even though employees are being called back to the office increasingly (for at least some part of the week), WFH is here to stay. Now, three years after the beginning of the pandemic, we can see settled WFH patterns. Even public transit journeys have now stabilized at 35% lower than before 2019 levels, indicating that hybrid-WFH is the dominant scheme for professionals and managers. Based on data provided by 4,000 US corporates, we understand that certain industries, such as food service, accommodation and retail operate completely on-site. This covers approximately half of the questioned firms. Around 40% of the firms combine WFH and in-person in one way or another. The remainder works fully remotely.

Many of us enjoy the perks of being able to work from home, cutting down on commuting time and adding additional space for family time or hobbies. And the WFH situation is not only beneficial for employees, but also employers win valuable time. Not having to commute, saves 72 minutes a day on average, and 90+ minutes in China, India, Japan, and Singapore. Employers gain 30 minutes (40%) more work a day, boosting productivity. Employees gain 42 minutes for leisure, caregiving, and housework.

But on one hand the new hybrid way of working provides opportunities for individuals, on the other hand it's presenting problems. Office space reductions are causing vacancies. One of the latest surveys show that US firms are still planning reductions in office space. These reductions are relatively small (approximately averaging 1.5%) as the hybrid-WFH model has proven to work best when all employees are in at the same time. Small or not, reductions are still present, and before the WFH balance reached a level of stability, this used to be much bigger.

Those reductions have a big effect on our city. For example, in the heart of Midtown (Manhattan) sits a multi-billion dollar problem as blocks of old offices are vacant. These buildings are too old to attract new tenants but are too young to be demolished. A study estimated that lower demand because of WFH may cut 28%, or $456 billion, off the value of offices across the US. About 10% of that would be in New York City alone.1

The office vacancy rate in Manhattan (the country’s largest office market) was at a 30-year high of 21.5% in the second quarter of 2022. Older buildings were affected the most; Buildings built after 2010 (or even after 2015) saw a substantially stronger occupancy than the older buildings that have lower quality. Some companies left their offices to cut back on costs. Others are relocating to brand-new offices in prime locations to attract new talent and pull employees out of their WFH comfort. All these empty offices led on their turn to the downfall of a lot of restaurants and other business who relied on the day-time work traffic.

And not only Manhattan is dealing with empty offices. Physical office occupancy in the major office markets of the United Stated dropped from 95% end February 2020 to 10% one month later and has remained low ever since. Mid-September 2022, occupancy has come back to 47% only. About 70% of college educated workers worked (at least partly) from home during the pandemic.

In a study among 105 US office markets, a 17.54 percentage point decrease in lease revenue has been documented between January 2020 and May 2022. The quantity of newly signed leases within the studied data set fell from 253.43 million square feet per year before the pandemic to 59.32 million square feet per year in May 2022.

The majority of running leases have not yet come up for renewal, implying the vacancy numbers can go up even more. Even when leases do get renewed, they are often renewed under different terms: Tenants are more likely to renew for a shorter time. Leases with a duration of less than three years increased while leases with a duration of 7+ years decreased substantially.

Predictions for the future have been calculated based on two scenarios.

1) The economy returns to a no-WFH state: office valuations will be pushed back towards an average value in 2029 that is 39.18% below 2019 values.

2) We keep the WFH state: office values in 2029 will be 59.86% below pre pandemic levels. 2

Will Face-lifting the city Help?

Some New York State officials are trying to give Midtown Manhattan a boost by reshaping it with one of the largest real estate development projects in American history: 10 large office towers around Penn Station, the busiest transit center in the country. The costs for "fixing" the station are estimated to be around $7 billion. However, documents released by the state’s economic development agency suggest that the total costs of the project will be $22billion including transit improvements and a station expansion plan. The office towers are meant to help paying for renovation of the underground station

The renovation would add taller ceilings and new entrances to the station but no additional tracks or platforms. But the most significant impact for the city would be the new buildings around the station. New towers that would encompass roughly 18 million square feet of new space surrounding Madison Square Garden, which sits above Penn Station. About three-quarters of the additional space would be devoted to offices, while the rest would provide ground-level storefronts, up to 1,800 residential units and a 472-room hotel. The new office towers are expected to take two decades to complete and require the demolition of numerous properties on several blocks, including a 150-year-old Roman Catholic church. The plan has attracted some fierce opposition. Nonetheless the Penn station will see its renovation. The funding plan got approved in July and in September the contract was approved.

Another viable solution for the vacancy is to convert empty office space into apartments. Manhattan has an estimated population of 1.63 million people who are living in an area of 23 square miles (only!). This gives Manhattan a population density of 70,826 people per square mile, or 27,346 per square kilometer. Manhattan is the most densely populated of the five NYC boroughs and also the most densely populated county in the United States.

We can conclude that Work From Home has pros and cons. Less commuting, more free time, happier employees on one hand, but higher vacancy rates and fallen businesses on the other hand.

Start-ups have really benefitted from the reduced need for office space. Without a physical office it is much cheaper to start a company. During 2022 start-ups continued to surge. After an initial Spring 2020 drop, business creation rebounded to 20%+ above trend through 2022.

What impact do you expect?

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1 https://www.bloomberg.com/graphics/2022-remote-work-is-killing-manhattan-commercial-real-estate-market/

2 https://www.nber.org/system/files/working_papers/w30526/w30526.pdf

3 https://www.nytimes.com/2022/08/29/nyregion/manhattan-offices-hochul.html

4 https://www.forbes.com/sites/richardmcgahey/2022/10/29/empty-offices-can-be-converted-to-apartments-new-yorks-story/?sh=53b423fd37bb

5 https://www.bloomberg.com/news/articles/2022-08-18/what-penn-station-s-6-billion-makeover-means-for-nyc-quicktake

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