The office flywheel
Why the job of office real estate planning will look more like managing a bar than owning a ranch
Last month the Wall Street Journal published a piece titled “The Return to Office is Stalling.”
As I predicted last December, office utilization rates — as measured by building key card swipes — have remained flat at roughly 50% of the pre-pandemic norm (in some metros like the Bay Area, that number is closer to 30%). Many have expected a bump in those numbers, but the weeks continue to go on — the COVID emergency now declared over by the Biden administration — and alas, no change.
Keep in mind that prior to the pandemic, offices in the U.S. were utilized, on average, about 65% of the time. That is, for every thousand square feet of office real estate, on any given day, about 650 were being used, 250 were leased but unused, and 100 were unleased. That 250 — the orange bar below — is space that a firm pays for as a “buffer” in case they might need it: a kind of premium for the small number of days each year they have clients or visitors and need extra capacity.
Put those two numbers together and you are left with a stark reality: 50% of 65% is 32.5%. That is, we can extrapolate the average office building in the US is about 1/3 utilized today. (In the Bay Area, utilization is about 30% of pre-COVID, meaning buildings are only 1/5 utilized).
If you are an owner of a commercial office building, these numbers are frightening. Many ignore these utilization numbers, instead focusing on more traditional lease vacancy rates (the gray bars above). While certainly worrisome, looking at the trend in vacancy rates is a lot less scary than looking at the trend in utilization: an increase from ~12 to 17% nationwide. More than 80% of office space in the U.S. remains leased today.
The question becomes: is office utilization a leading indicator of where office lease vacancy will be?
Let’s say you take the Journal’s headline piece and you assume that the current hybrid work norm will stabilize — that current office utilization will be the ‘new normal.’ Teams will use office space, on average, about half as much as they did before.
If you believe that, then in order to believe that utilization is NOT a leading indicator of vacancy, you have to believe that companies will be willing to continue leasing the same amount of space even when using half as much of it. Before, companies were willing to pay a roughly 25% rent premium for extra space that might only be used a handful of days a year. Assuming companies lease the same amount of space, that premium now doubles to 50%.
Will tenants be willing to pay for an asset they only use, on average, 50% of?
If they had no other choice — they need office space, and that’s the only way to get space that fits everyone, I’d say yes. They will pay for it.
But, they will have other choices.
If your teams are only coming in a couple of days a week, and if you are large enough to be able to reconfigure when different teams come in, in theory you could make a much smaller space serve the same number of people.
Crucially, if you can figure out how to do this, you’re probably going to do it NOT because you’ll save money on office rent, but for something else entirely: to avoid having a space that feels dead. There is nothing more demotivating to an employee who chose to commute in than to walk into an office that’s completely empty. If social is the number one reason employees come into the office, to see lots of other people around you actually matters.
You can call this a ‘flywheel’ effect: the more utilized a space is, the more likely people are to come in.
There’s a real incentive, then, for firms to figure out how to optimize space and teams in entirely new ways. Who’s coming in, when?
The task of office use planning I predict will change from something like that of a cattle farmer to that of a bar owner. Because demand is no longer constant each day, AND because of the flywheel effect, you now want to be thinking about coordinating people in ways that maximize the space utilization.
Doing so won’t be easy. You’ll have to:
Set a company-level hybrid work policy that management is bought into
Have teams set team-level agreements that employees are bought into
Switch to hoteling-style desks if you haven’t already — no more personal / dedicated space
Coordinate teams to come in on different days (which may require forcing some teams to come in on days they’d prefer not to, like Fridays)
No individual was responsible for these difficult tasks before, and few are going to want to do it. No matter how you do it, people will be upset.
But, if you believe that some in-person work is critical for your business, and you believe the flywheel effect is strong enough, you’re going to figure it out. Tools and tech might make it easier, and once some companies do figure it out, the others will probably follow.
My prediction is this will take time, with some firms and industries leading the pack, but it will happen.
And as this does play out, office vacancy will gradually continue to tick up over the next four years. The pain owners experience will be chronic. But do not let that fool you into thinking this will end alright — office demand will probably fall 30-40% by the time this is over. Best to act sooner before it’s too late.