Office demand comes roaring back as stocks in the space play catchup

If you’re not back to the office already, you may be soon.

After a five-month lull, likely due to the extremely contagious omicron variant of the coronavirus, new demand for office space jumped in March. Barring another major setback in the pandemic, it will likely continue to rise, but offices themselves will undergo a makeover as demands from workers change.

Optimism in offices is already showing up in stocks behind the office sector. As rents rise and vacancies fall, earnings are beating expectations.

Office demand, as measured by new tenant tours, was 20% higher in March than February and was up roughly 8% from a year ago, according to a recent report from commercial real estate technology platform VTS. The tours are considered a forward indicator of new leasing.

The office vacancy rate in the first quarter of this year was down 18 basis points from a year ago to 18.1%, according to Moody’s Analytics. It’s the sector’s first annual decline in five years and marked improvement from a vacancy rate of 18.5% at the height of the pandemic.

“Demand for office space this month is more in line with what we expect to see this time of year,” said Nick Romito, CEO of VTS. “Looking ahead I expect that we’ll continue to see demand ebb and flow in a typical seasonal pattern, but to really get out of the prolonged period of depressed demand we have seen as of late, we’ll need to see demand exceed seasonal norms over the course of many months.”

Demand is slowly driving up rents. Asking and effective rents rose 0.2% and 0.3%, respectively, during the quarter, the best performance since the beginning of the pandemic, according to Moody’s. Annual rent growth also reversed its downward trend.

Despite the surge, however, new demand for office space is still just two-thirds of its pre-pandemic average, based on the VTS metric. Boston, Chicago, Los Angeles, New York City, San Francisco and Washington, D.C. make up the best gainers, regionally.

And while the signs for the sector are optimistic, office-related stocks, largely REITs, are still mixed.

Boston Properties, Hudson Pacific, SL Green and Empire State Realty Trust are all still below pre-pandemic levels. For example, Hudson Pacific dropped 40% at the start of the pandemic and then slowly began climbing back. It is up 28% from the pandemic low but is still in the red year-to-date.

Some, like Boston Properties, have come climbing back over the past year. Boston Properties reported better-than-expected earnings for its first quarter Monday.

“While rent growth takes time, the demand for space gives BXP confidence that COVID is over, as tenants bring their employees back, which should accelerate the occupancy rebound, providing upside to earnings,” wrote Alexander Goldfarb, a REIT analyst with Piper Sandler in a note to investors in March.

A new survey of 185 office-using companies in the U.S. by CBRE found 36% of employers said return to office was already underway. Just over a quarter said it would be by the end of June. About 13% said a return to office was up to their employees, and 10% were still uncertain.

According to the VTS report, offices were still less than half full in April, at 43%. But that marked a pandemic high.

When workers do return to the office, they can expect to see significant changes, not just in cleanliness and air filtration, but in the way they go about their business.

CBRE’s survey found employers pointing to more in-office technology tools to enhance video conferencing, as well as occupancy sensors and touchless options. There will be more so-called “free address” seating. Nearly two thirds of companies said they intend to have open desk use rather than assigned offices or cubicles.

There will also be widespread hybrid work, with 70% of employers saying they intend to allow workers to be both in the office and remote. Nearly half said they want that to be an equal mix. Because of that, they expect more flexible office space. Just over half of employers said they will add different forms of that, from open desking to, “dedicated floors indistinguishable from their traditional office space,” according to the report.

“That flexibility is desired for any number of reasons, including ability to scale up and down, give employees more choice over where to work or even just preserve capital,” said Julie Whelan, global head of occupier research at CBRE. “But the employees do benefit from being in productive space in good locations with typically very good amenities and experience.”