Urban Exodus? Suburban Offices May Offer New Appeal

With the coronavirus (COVID-19) pandemic altering the way we live and work, there may be new demand for offices in transit-oriented development (TOD) communities located in submarkets outside of densely populated urban cores.

City centers have long been a draw for buyers and tenants. But as workers feel increasingly unsafe commuting on crowded public transit systems and increasingly more comfortable logging on to work laptops in their pajamas, all while their companies continue to face the high rent costs associated with city offices, employers and employees alike may be seeing suburban workplaces more favorably than ever.

LoopNet spoke to owners, developers, appraisers and analysts to assess how behavioral and workstyle changes in this “new normal” and beyond could impact office valuations and demand for both urban and suburban properties.

Commuter Caution

Employees will be wary of using public transportation until governments create a more systematic procedure for sanitizing busses and trains, says Bruce Kellogg, MAI, FRICS, an experienced appraisal consultant. Until commuters feel comfortable, stations will see very little use.

“If there isn’t a requirement to uphold social distancing, this will result in negative consequences and [urban] values could drop due to the fear factor of developing Covid-19 through commuting or in the workplace,” he says.

The New York City market, which not only is the largest and most expensive, but has experienced the greatest suffering in the past few months as an epicenter of the outbreak, paints an extreme picture of the impact the health crisis could have on the office market.

Brokers in the city are saying they’re hearing from Manhattan-based firms looking to open suburban offices as employees won’t want to take the train into the city. Therefore, TOD properties in New York submarkets stand to benefit from some of the overall fundamental shifts being witnessed. While the draw of these locations is that they’re often located near commuter transit which will remain unnerving in the near-term, employees will likely feel more comfortable working outside of the city, especially if they are commuting in their own vehicles.

An additional desire for residents to move out of the city, driven in part by an interest in seeking larger living spaces that can keep residents from feeling cooped up in small units, away from roommates, or allow for home office setups and provide more open outdoor areas like private yards as social distancing measures continue, will also make office locations close to home attractive to employees.

In a video from CoStar, publisher of LoopNet, John Affleck, CoStar's vice president of market analytics, reports that tenants seem to already be taking advantage of cheaper properties and cities.

“Why work at home in New York, when you can just as easily work from Philadelphia or Hartford and save some $1,500 in rent,” said Affleck, noting that CoStar data shows rents are falling in some of the most expensive cities like New York and San Francisco and rising in their less expensive counterparts, such as Sacramento.

“What will be interesting to witness – and should reveal itself over time – is if corporations will seek more suburban office exposure,” says Thomas Walsh, Managing Director at Walker & Dunlop Investment Sales in Short Hills, New Jersey. “Should this occur – even from a ‘hub-and-spoke’ approach – the much-maligned suburban office fundamentals could have a considerable rebound and drive demand for many investment profiles, especially suburban multifamily.”

Perhaps redevelopment opportunities will emerge along auto-dependent stretches of commercial shopping centers, many of which currently lack any pedestrian connectivity or character, he suggests.

Walsh says all bedroom communities outside of New York City, whether transit-oriented or not, are classified as suburban or secondary submarkets, so the phenomenon of tenants seeking refuge from the city will filter through the entire market.

Not so Fast

Some experts don’t believe the pandemic will have a long-term impact on the desire to work or live in urban hubs.

We’ve seen the impact of a crisis on urban commercial real estate properties before. Think of post-September 11 apprehension, when many speculated that no one would ever again lease the top floor of a high-rise. “This fear was quickly forgotten,” one analyst quipped.

“Cycles will always be present, and cities will continue to thrive as the product of human evolution and our innate desire for connection, which will not suddenly change course as the result of one pandemic,” says Jeff Kayce, senior vice president and managing director at Greenbelt, Maryland.-based Bozzuto Development Co. “I don’t anticipate that Covid-19 will cause a loss of interest or value for transit-oriented development.”

Conversely, Walsh says, “Clearly if unemployment is protracted and finds itself permeating through all sectors of the economy, then all assets will suffer a valuation correction. But if unemployment can stabilize and then reverse over the next quarter as economies re-open, we should plan for a very active market in late 2020 leading to strong transaction demand in 2021.”

Transactions at a Standstill

Currently, data points are too scarce to determine buy and sell trends this early on in the pandemic. And it looks to continue that way in the near future, especially as the economy remains uncertain.

“Our baseline forecast calls for a beginning to the recovery at the end of the year based on data from Oxford Economics,” Brooks Staley, senior consultant at CoStar Advisory Services, says. “Advisory Services believes that a more conservative timeline would stretch into 2021, given that states are likely opening back up somewhat prematurely. The baseline calls for a return to levels of employment reached in January by the latter half of 2022 – also likely to be more optimistic than the in-house view of a more gradual growth path post-Covid.”

Kevin Shannon, co-head of U.S. Capital Markets at advisory firm Newmark Knight Frank’s Los Angeles office, says institutional capital has been on the sidelines for office space.

“The vast majority of office transactions have been paused. We are closely monitoring market fundamentals and advising our clients on when to launch new listings,” he says.

Buyers and sellers are still asking what post-Covid rents will look like, and what the velocity of the recovery will be, which is what’s halting sales.

Jeff Burns, senior managing director at Walker & Dunlop in the San Francisco Bay Area, says he’s seen very few west coast sales. “Most sellers don’t want to take the risk discount buyers would demand to transact right now,” he says. “We are seeing owners refinancing into flexible floating rate debt if they have a maturity rather than sell right now.”

However, there is still an insatiable demand to deploy equity and debt considering what the economy is going through, says Walsh. “While an adjustment to near-term underwriting is having an effect on valuations, over time, as occupancy and collections remain strong, the bid/ask spread should contract. This will allow for transaction volumes to increase. Agency financing is still eager to place capital, which will help with bridging the gap should cap rates widen from their historical lows.”

Near-term underwriting assumptions might be scaled back, he adds, “and we feel confident that tenant demand will increase and investor yield requirements will not move considerably for quality assets with high collection and retention rates. While we’ve seen suburban TOD submarkets increase development pipelines during this past cycle, it pales in comparison to the higher-density, truly urban core, which will make the absorption of units more fluid for secondary TOD assets.”

Preserving Value

Landlords and building owners can stabilize the value of their assets by ensuring the buildings are ones tenants feel safe coming to as the nation returns to offices. Kellogg notes that it will be important that the brokers who market properties for sale and/or lease feel comfortable that the owners and managers have done all they can to ensure the safety of building occupants and have taken precautions to protect them from illness.

“Until a vaccine can be developed, everyone will want the assurance that they are safe. If, however, this is not done to satisfaction, and if the numbers rise for those becoming ill, then [office] values could drop or remain low due to the lack of confidence for people to return to work or continue to be at work in jobs where personal contact is part of their daily routine.”

Kellogg adds, “All professionals involved in real estate – whether sellers, owners, property managers, tenant representatives and asset managers – should emphasize that values may not drop if they implemented the guidelines that will bring people back to work and, therefore, provide comfort and relief that they will not be susceptible to illness. At the end of the day, it’s all about confidence for all concerned.”