Office inventories take a hit as concerns over omicron variants add to growing demand slowdown

Pedestrians walk past commercial real estate in Manhattan.

Michael Nagle | Bloomberg | Getty Images

Shares of the nation’s largest office REITs fell further on Tuesday as the office market faces new concerns over the Omicron variant of Covid. This comes on top of a further cooling in demand for office space, which had improved significantly in the first half of this year, with vaccinations against Covid19 promising a safe return to work.

Shares of the largest office real estate investment firms, like Boston Properties, SL Green, Douglas Emmett and Alexandria Real Estate Equities, all fell sharply on Friday, when word of the variant spread, and have yet to recovered. These shares had risen by around 25% since the start of the year.

The S&P 500 also fell on Tuesday, down more than 1.5% in morning trading.

New office demand fell in October to the lowest rate since the first quarter of this year, according to a new report from VTS, a commercial real estate asset management company. This is the second consecutive monthly decline. Since peaking in August this year, demand is now down 30% nationwide.

VTS tracks new tenant office visits, in person and virtually, in major US markets as an indicator of upcoming office rental activity.

Demand for new office space had increased from the low in June 2020. It had increased by 444% in August of this year. The growth in demand was likely due to a more optimistic return-to-work scenario, as cases of Covid19 decline and vaccinations ramp up. But new concerns are turning the trend upside down.

“As we move past 18 months since the start of the pandemic, employers and employees have largely adapted to a new way of working and in many cases that means permanent remote or semi-remote work. “said Nick Romito, CEO of VTS.” The longer we stay in limbo – the place where, even with vaccines and better Covid-19 treatments, there is still trepidation about return to work – the more likely it is that we will have a permanent loss in demand for office space and possibly a new normal. Time is not on the side of renting office space.

While all major markets saw lower demand, Los Angeles, San Francisco, Boston and Seattle had the worst. On the other hand, New York, Chicago and Washington, DC, saw new demand drop 10% or less in October. The differences between these markets are likely due to their strength before the pandemic (DC and New York were extremely strong), as well as the prevalence of companies with user-friendly remote work environments.

Demand also varies depending on the type of property. This is not taken into account in the national table.

“The divergence between the premium desktop and the generic desktop is accelerating,” said Alexander Goldfarb, senior research analyst at Piper Sandler. “The bulk of leasing occurs in new construction and buildings that have been heavily renovated recently. The losers are ordinary office towers. Covid has accelerated this trend.”

Goldfarb said he was less concerned with the variant and more with competition between companies for a quality workforce.

“The big problem for these companies is the big resignation. Companies are reluctant to force a return to power if they feel their employees can quit and go to another company,” Goldfarb said.

Businesses can use the latest variant to push back the return to office space, he argues, but office fundamentals are still favorable.

“Our concern on the REIT side is that the bureau is going to be a repeat of the retail business during the Amazon crisis a few years ago. Equity performance is pulling away from fundamentals,” he said.