The new post COVID pandemic real estate market is now a year in the making, and office space leasing activity has been reduced in half. With 50% of the leasing activity lost, vacancies are rising, and the quantity of sublease space for lease on the market has grown exponentially, which puts downward pressure on direct lease rates. Property owners are taking longer than we might like to adjust lease rates while they figure out the extent of the coronavirus damage, and at the same time, they are just starting to realize the battle they are in to retain the tenants they have, especially at the pre COVID lease rates they were achieving. The pandemic is only part of the reason for negative absorption. Absorption rates were already in decline due to companies having fewer square feet per employee. Now, with the pandemic, this trend has reversed. Companies are now focusing on de-densification; modifying their workplaces to accommodate social distancing for those employees that will be in the office. Working from home does provide for reduced real estate costs, but those savings will be lost to companies having to create more distance between the employees in the office.
The impact of work from home trends will continue to slow the office market, but the use of office space will play an important role in the recovery of the economy. The recovery of the office market is going to be a slow process, with some predicting the market will be unbalanced until 2025. The period between now and then will be especially murky for office real estate. There will be a large reversal of the work from home trend. It may not be 5 days in the office, but will be substantially more than it is today. Office space does provide benefits that are difficult to replicate or keep in place when all or most of your work force is remote, such as face-to-face contact, which is important for collaboration and creativity. Employees have begun to feel lonely and depressed working from home full time on zoom meetings and feel they have lost their connections. As employees return to the office, companies will begin to embrace low-rise buildings with the ability to reach offices via stairs rather than elevators and a shift to smaller suburban locations closer to where their employees live. It is highly possible that lower floors of office properties will become more valuable. Investors, who have been sitting on the sidelines with tons of cash, are all fired up and ready to pick up distressed commercial real estate at bargain prices in the very near future.
Denver's office vacancy at the end of 2020 increased to 12.63% up from 9.96% one year ago. Net absorption was over negative 3.6 million square feet, where a year ago it was just over positive 1.7 million square feet. Average asking lease rates for all metro Denver office space continued to increase to $28.43 per rentable square foot on a full service lease at the end of 2020. Available sublease space in the Denver market now exceeds 4.6 million square feet, which represents an 80% increase from one year ago. This is a record breaker for the Denver office market, as sublease space now represents over 20% of all the office space currently offered on the market. 2020 ended with Denver having approximately 2.6 million square feet of office space under construction, compared with 3.1 million square feet one year ago.
Office use is not going away. It will just look a bit different from before, and will still play a major part in corporate culture. Employees will begin to push back against remote work policies as they recognize they have been shouldering expenses and costs that ordinarily would have been paid by their employers. Expectations are for the office market to move more strongly to a tenants market, with office lease asking rates contracting in 2021 and 2022 by 10% to 20%. Tenants of all sizes should be able to command lower lease rates and significant incentives, including some we have not seen since the 1980’s; more free rent, increased tenant finish allowances, moving and cabling allowances, and discounted or free covered parking are just some. Property owners will be looking closer at tenant credit and ability to withstand another round of stay at home orders. Tenants with lease renewal options should make sure they have expert advice on market lease rates and not just accept a lease renewal rate proposed by their landlord. For companies that wish to relocate or build out new space, significant time will be needed to accomplish design, obtain construction permits and complete construction. For most tenants, starting the process 9 to 12 months in advance of your lease expiration is appropriate. For large tenants, starting 1 to 2 years in advance is necessary. Identifying upcoming space options, gaining market knowledge on other tenants negotiated lease rates and the incentives other tenants received, is necessary to achieve the best economics on your next lease decision. Retaining an experienced commercial real estate consultant to represent your company is imperative to navigating our “new normal”, accomplishing your goals, and keeping your companies occupancy costs as low as possible.