What will be the new normal for the office market?

“We’re cautiously optimistic for 2022”, says Adam Kot, Vice-President, Commercial Mortgages and Head of Origination at Addenda Capital, a multi-asset investment firm focused on sustainable investing. To improve the longer-term stability of financial returns for its clients — which include pension plans, high net worth individuals, insurance companies, corporations and foundations — Addenda manages a portfolio of high-quality commercial mortgages through its team of in-house experts. This provides a front-row seat to the real estate landscape.

“We believe property owners will find new solutions to generate demand for office space should we see increases to vacancy rates,” Adam Kot adds, pointing out the general “creativity and strength” of property owners in the Canadian real estate market. Both property owners and employers will be looking to find ways to attract workers back to the office, he says. “Employers and employees see the value of efficiency and team building that the office environment brings. This is essential to building company culture.”

As many cross their fingers hoping for an end to COVID and a return to greater normalcy, the office space market is showing signs of recovery, according to recent data.

The last three months of 2021 saw the first quarter of rebound since the start of the pandemic, wrote CBRE (source 1) in January 2022. “In stark contrast to the fourth quarter of 2020, net absorption totaled a positive 1.7 million sq. ft. in the fourth quarter of 2021. These gains even outpace 2019’s quarterly average of 1.5 million sq. ft. when global tech occupiers flocked to Canadian gateway cities,” CBRE pointed out. (Net absorption refers to the difference between space that has become occupied minus the space that has become vacant.)

In addition, the overall office sector’s vacancy rate rose just 10 basis points in the fourth quarter to end 2021 at 15.8%, CBRE added. “This is the smallest quarterly increase on record since the onset of the pandemic, signaling a likely turn in the market as three markets reported declining vacancy at year-end: Toronto, Vancouver and Ottawa.”

“We will keep an eye on how occupancy rates will be affected once restrictions are fully lifted”, says Adam Kot of Addenda Capital. However, one needs to “take a long-term view to all of this and avoid knee-jerk reactions to short-term vacancy increases,” he cautions. In other words, observing trends over a three- to five-year period, as leases mature, provides a better window to assess truly significant shifts in the market.

Faced with the immediate needs of tenants, what will landlords do to adapt? A partial return to the office could result in smaller space requirements for tenants, while others might want increased floor space for open concepts that allow for social distancing or other reconfigurations. For instance, tenants will be seeking spaces designed to encourage more socialization and collaboration including amenities such as breakout rooms and recreation rooms. Also important are health and wellness characteristics such as increased ventilation for air quality, improved lighting, additional greenery, or quiet rooms.

It is “clear that an evolving workplace will have a significant impact on offices and how they are used”, wrote consulting firm PwC in a report on new real estate trends in 2022 (source 2). And for real estate owners that are coping with new trends, “a changing world of work will accelerate the real estate industry’s ongoing shift toward becoming a more service-oriented business with a sharper focus on the user.” In this regard, real estate owners will face the challenge of better understanding “what their tenants’ specific requirements are.” This will very likely include technological solutions resulting in buildings where tenant presence may be enhanced through sensor-controlled airflow, lighting, heating, security, and accessibility.

Mixed use and sustainability

As landlords try to meet tenant demands for office space, “we may see opportunities for reconfiguration of existing office supply into mixed-use projects,” Adam Kot says, adding that this could include partially repurposing to include residential or retail components. The conversion of office space to residential space could help solve current housing shortage issues in many major centres. Such a conversion could make downtown space more appealing to people wishing to reduce their commute times. Many owners will also be reinvesting in buildings with a focus on sustainability improvements. Such investments will meet evolving demands from tenants and create more sustainability-focused real estate investments for the market, which “would obviously be a very positive outcome.”

For now, workers’ preferences seem to point to a hybrid model. “Once the COVID-19 pandemic is over, the hours that Canadian employees would prefer working from home might amount, in the aggregate, to 24% of their total work hours,” researcher at Statistics Canada wrote in October 2021 (source 3). “This estimate, which accounts only for worker preferences and does not incorporate employer preferences, equals almost five times the overall share of total hours worked from home observed in 2016 or 2018.” Among “new teleworkers”, “80% of them would like to work at least half of their hours from home once the COVID-19 pandemic is over.” The next few months might very well provide long-awaited answers on how successful the return to office will be, but it will be the next few years that will determine how this asset class will evolve.

---

Source 1 : https://www.cbre.ca/en/research-and-reports/Canada-Office-Figures-Q4-2021
Source 2 : https://www.pwc.com/ca/fr/industries/real-estate/emerging-trends-in-real-estate/report.html
Source 3: https://www150.statcan.gc.ca/n1/pub/36-28-0001/2021010/article/00001-eng.htm