Postpandemic Real Estate Strategies: It Pays to Be Nimble

Jon CritelliJon Critelli, Managing Director Internal Audit and Financial Advisory – Capital Projects
Sarah TuchlerSarah Tuchler, Associate Director Internal Audit and Financial Advisory – Capital Projects

Of the many things to consider during the pandemic, one of the more challenging areas is real estate. To a large extent, companies have done an admirable job of relocating large portions of their workforce to work-from-home (WFH) status — and on very short notice. But the current crisis will ultimately pass, and now is the time for organizations to consider how the changes they are making now will affect their future needs regarding office and retail space. Will WFH become the norm after the pandemic? Will retail space still be in demand? And overall, how should organizations budget for real estate and capital expenditures?

The answers aren’t simple, because there are so many unknowns. A vaccine for COVID-19 may or may not be available in the next few months. And even if it is, it will take months to achieve inoculation of a critical mass of the population. Furthermore, we don’t know what the state of the economy will be at that point. But we can get a better assessment of the future real estate environment if we examine the key elements involved and look at them from both short-term and long-term perspectives.

First, let’s start with the trends that existed before the pandemic. WFH was on the rise, though it was far from widespread. It received a boost from the 2008 recession when many firms encouraged employees to work from home in order to save on office rent. But as late as 2018, only 5.3% of American workers regularly worked from their residence, though nearly two-thirds did on occasion. Still, the trend was moving inexorably toward WFH, helped along by worker demand for more flexibility and studies that showed both worker output and employee satisfaction increased with a WFH workforce.

Another trend was the growing adoption of open-floor configurations to increase collaboration. Last year, real estate firm CBRE reported that only half of office space was set aside for individual “heads-down” work. However, following the initial enthusiasm for an open-office configuration, many firms began to realize that their employees couldn’t conduct sensitive business or tasks requiring concentration with a whole floor of people within earshot and with constant background noise. The open-floor configuration was beginning to lose its allure, and the pandemic conditions may just be the decisive push to swing the pendulum the other way.

Current Environment

COVID-19 will likely accelerate the trends underway and may reduce the total office footprint even further. Many major companies are extending their widespread WFH arrangements, and one leading insurer has closed five major office sites around the U.S. and put its 4,000 employees on permanent telecommute status. Wells Fargo recently announced plans to reduce its brick-and-mortar footprint to save costs, building on a banking trend that has only accelerated with COVID-19-related lockdowns.

For existing office space in the short term, a number of questions arise. Will elevator users be “metered”? Will restrooms have fewer stalls? The answers will depend on highly specific circumstances in each building, such as the number of users. However, reconfiguring the actual workspace is a larger, and more universally relevant, problem. Conference rooms that once housed 10 people may now be limited to five, for example. And floor plans will require much more privacy, either through individual offices or the return of cubicles and other divided workspaces. Some measures, such as changing a building’s airflow or adding air filtration, could be quite expensive.

Adding to the uncertainty, no one knows at this time whether a vaccine against COVID-19 will be effective, or for how long. After all, COVID-19 is a virus and could mutate periodically, similar to the seasonal flu. If that proves to be the case, our society will have to learn to cope with an airborne virus for an extended period of time. Landlords will have no choice but to address the obligatory health and safety table stakes in their pitch to occupants.

As with any crisis, there is the risk of overreaction. If an effective vaccine does become widely available by the spring of 2021, then many of the space changes may no longer be needed. On the other hand, any recent jurisdictional requirements related to spacing, cleanliness, occupancy and other hygiene issues may remain for the foreseeable future, regardless of what happens with the virus.

Given such uncertainty, companies (and landlords) would be wise to opt for less expensive, temporary solutions such as plexiglass shields, where appropriate — while keeping a close eye on changes in health, safety and building requirements by their local governments that may necessitate more permanent solutions.

Rents Trending Down

For landlords, the WFH trend led by larger and more technologically mature companies poses yet another problem — it may be difficult to find anchor tenants for office buildings. Almost certainly, the cost per square foot will come down — and in some cases, already has. In a tenant market, landlords will also likely feel the need to fund any improvements, instead of passing the costs along to tenants.

Falling rates are good news for smaller companies. With declining rates, these smaller tenants will be able to grab prime real estate, and major cities will likely see a more diverse mix of firms in spaces that were previously reserved for larger companies, or “anchor” tenants.

To Abandon HQ or Not

Companies willing to abandon the downtown office in favor of a WFH workforce should consider several factors. A headquarters in a major city like San Francisco brings a certain prestige and ambiance that can help with recruiting and corporate branding. A robust HQ is also important for employee interaction and shared equipment, and it enables new recruits to absorb the company culture and gain the visibility they need to advance their careers. But such locations will be weighed against the availability of housing and public transit, as well as the commute involved. Other factors include the preferences of workers for WFH arrangements and regional offices, which are tied to lower housing costs and a reduced carbon footprint. The latter is becoming more important, both to an increasingly green-minded workforce and investors focused on a company’s environmental, social and governance (ESG) performance. For many companies, the answer may be a smaller HQ, one that serves more as a meeting environment than a working one (to augment virtual efforts to collaborate, make key decisions and engage in community building), combined with a largely distributed workforce.

Retail Considerations

For retail operators, location is becoming less important, especially in the short term during the pandemic. Consumer online purchases have seen a tremendous surge (Walmart ecommerce rose 74% during the first quarter), while in-person shopping has been sporadic — up one month and down the next — roughly mirroring government-ordered closures and reopenings. As a result, some major companies, such as Microsoft, are pulling out of brick-and-mortar outlets altogether, while others have stopped opening new stores for the time being and are focusing their resources on maintaining and improving the customer experience of their current outlets.

A Bifocal Strategy Is Key

For both retail and nonretail firms, the pandemic presents an opportunity to revisit actual space requirements and reconsider the application of working capital. Now is the time to determine which projects are of the utmost importance and which can be deferred. Nimbleness is key here, and where possible, firms should delay long-term commitments for shorter ones — at least until the smoke of uncertainty clears.

Looking forward, it’s important to keep an eye on both short-term and long-term timelines and to weigh the costs of acting on both. To be sure, there will be opportunities during the pandemic that can reap lasting benefits, not the least of which is learning the advantages and shortcomings of WFH as it applies to individual industries. But in a stressed environment where certain factors, such as health and safety, can skew markets, organizations would be wise to be agile and ever alert to their operational needs and the changes in the marketplace as they unfold.

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