No one disputes this: The COVID-19 pandemic hit the office sector as hard as any asset class – or even harder – in commercial real estate.
But what does the future now hold for this still-struggling sector? In the Twin Cities, at least, brokers working the office market say that this sector is starting to show signs of a rebound, even as vacancy rates remain high.
But as the office market recovery continues, expect to see some pain. Not all office buildings in the Twin Cities and their suburbs will survive. Not all workers will return to the office on a full-time basis. And those companies that do want their employees to come back might have to leave Class-B or -C space and seek new space in Class-A buildings.
The good news, though, is that these challenges are not insurmountable. And local CRE pros say that the future looks brighter for the office sector in the Twin Cities market.
The challenge: Getting workers back to the office
The most immediate challenge companies face today? Getting their workers back to their cubicles, conference rooms and offices.
As Jim Damiani, executive managing director with the Minneapolis office of Newmark, says, “Companies today need to give employees a real good reason to come back into the office.”
Why? The nation’s unemployment rate is low. And in Damiani’s home market of the Twin Cities, it’s even lower. Workers have more options today when it comes to finding a job And if they can find one that lets them work from home, at least part of the time, the odds are good they’ll take that position.
But companies can provide incentives to encourage their employees to return to the office. Today that means providing a high-quality office space with clean air, top-notch security and amenities such as on-site fitness centers, cafeterias serving healthy foods, outdoor areas and plenty of collaborative spaces.
It helps, too, to have an office that is located in a walkable community, so that employees can walk to restaurants, retailers and professional services.
This is why the flight to quality in the office market is a real thing, not just a buzzword. Companies are moving to class-A office space as a way to get their employees back to the office. They’re relying on this higher-end space, too, to attract the top workers in their fields.
Damiani said that two new office developments opened in the Minneapolis market during the pandemic, one in the city’s core and one in the nearby suburb of St. Louis Park. Both of those developments – 10 West End in St. Louis Park and RBC Gateway in downtown — have attracted plenty of new tenants, even during these still-challenging pandemic days.
The reason? Companies are ready to make the move to higher-quality office space, with many willing to spend more per square foot as they reduce their overall office footprint.
“Today, it’s all about the experience,” Damiani said. “Companies want buildings that provide the best systems, not only top amenities such as natural light and walkability, but also the best air quality and security systems. If they provide this, companies can feel more confident about telling employees to come into the office. They can tell them they are providing a better experience than they were before the pandemic.”
Office life returning to the CBD?
Tate Krosschell, managing director of the Minneapolis office of Avison Young, said that downtown Minneapolis has long been known as an office market heavy with Fortune 500 companies. Because of this, the health of the Twin Cities’ office market is heavily influenced by the performance of these larger employers.
The good news? These companies are slowly bringing more of their workers back to the office, even if it these workers are largely following a hybrid schedule.
“These companies are not bringing back 100 percent of their employees, but the number who are back in the office is the highest it’s been since the pandemic started,” Krosschell said. “There is more vitality in the CBD today.”
Adam Barrett, vice president with the Minneapolis office of Colliers, said that at least two of the national companies that he represents — one a law firm and the other a vendor that works with Target — are looking to lease new office space in downtown Minneapolis.
To Barrett, that’s just one more indication that leasing activity in the Minneapolis CBD office market is on the rise today when compared to both 2020 and 2021.
“Leasing activity is definitely up over the last year,” Barrett said. “The trend has remained stable, too, that it’s typically the small to medium-size businesses that are bringing people back to the office and looking to lease new space. The larger companies are still kicking the can a bit. They are still signing one- or two-year extensions to to figure out what their work model might look like in the future.”
This wait-and-see approach is understandable. As Barrett says, office leases are typically the second-highest cost that most businesses take on after personnel. Larger companies spend more on their office leases and are more cautious in making long-term decisions because of this.
“The larger companies that had to transition to full-time remote work are the ones that are being a bit more methodical when making their future plans and signing new leases,” Barrett said.
The suburban areas of the Twin Cities market are seeing more employees returning to the office, too, Krosschell said. These markets are home to a greater number of the smaller, more regional employers, she said. These companies have been more flexible during the pandemic. That has provided at least a small boost to the performance of the suburban office market, Krosschell said.
“They are have been able to quickly design new work schedules,” Krosschell said. “They have been able to get people back in the office more quickly than some of the bigger companies have been able to do.”
As companies move to better-quality spaces, many are reducing the amount of space they need, Damiani said. For instance, a company that was leasing 50,000 square feet at $30 a square foot might now lease 30,000 square feet at $45 a square foot. They are still saving money each month, but now they can provide a better-quality space for their employees.
Damiani says that Newmark’s Minneapolis office ranks office buildings on a five-star scale for amenities and the experience inside the buildings. Office buildings that score at least 4.5 stars on the rating system have an occupancy of 63.4%, Damiani said. On the other end of the scale are suburban corporate office campuses. These office spaces are saddled with a vacancy rate of 31.3%, Damiani said.
“Those bigger suburban campuses are struggling the most,” he said. “They don’t have as much walkability. They don’t have the amenities that tenants want today. Those large spaces can be lonely when only 20% of the people are showing up.”
Krosschell said that there has been an amenities arms race as companies try to convince their workers to return to the office. The amenities that workers want, though, have changed since the days of office beer taps and ping-pong tables.
As Krosschell says, workers have spent more time at home since the pandemic’s start in 2020. Many have discovered that they can work effectively from their homes. The office, then, needs to become a destination, offering these workers something they can’t get at home.
“The office spaces and the buildings themselves have to provide spaces where people can collaborate,” Krosschell said. “Offices have to be designed to help people be more efficient.”
Employees are looking for office spaces that are LEED-certified that have a low carbon footprint. They want fitness centers and spacious conference rooms. They like outdoor patios and rooftop spaces.
Barrett said that hybrid work is the reality today for most employers. He points to numbers that the Minneapolis Downtown Council have shared with him: According to the council, about 55% of the 216,000 employees who work downtown have returned to the office in some capacity. These workers tend to come into the office two to three days a week, with Tuesdays, Wednesdays and Thursdays being the most active days.
But what will bring more of these workers back? Barrett said that it’s about invitations.
Companies have to invite their workers back into the office several times. This gives workers the chance to, as Barrett says, “dip their toes” into leaving their home offices. They can try out coming back to the office in shorter bursts. As they get comfortable again, many might return to the office on a more regular basis.
“Workers who have been working remote during the pandemic have a level of comfort that they are now accustomed to,” Barrett said. “We retooled our minds to working from home. That is natural. We adapt over time. The more invitations that larger companies extend for these workers to dip their toes back into the water before they fully immerse themselves back into office life, the more likely it is that these workers will regain their confidence and return to the office.”
The owners of many downtown Class-A office buildings used the pandemic disruptions as an opportunity to improve their properties. Many overhauled their lobbies and fitness centers, added more conference spaces and boosted their security.
These improvements are just one more tool that companies can use when persuading their employees to return to the office.
“Even though workers might be returning to the same buildings, the experience will be different,” Barrett said. “But for workers to experience these differences, they need to be encouraged to try out a return to the office. Once that occurs, after the first couple of times they come back, workers are more apt to return again to working in the office.”
Downtowns across the country were hit hard by the pandemic. Downtown Minneapolis-St. Paul was no exception, and the Twin Cities also had to deal with the protests and unrest following the murder of George Floyd.
Damiani, though, says that he is seeing positive signs downtown. Many of the restaurants in the Minneapolis Skyway system are seeing long lines again, he said. At the same time, a growing number of employers in downtown have brought their employees back to the office at least on a hybrid schedule.
“We are predicting that 2023 will be a very active time for the local office market,” Damiani said. “A lot of people during the pandemic did short-term leases. They kept their current space because they didn’t know what would happen. A lot of companies extended their leases for just a year or two. Companies now are starting to consider and do long-term leases. This is going to increase activity next year.”
Tenants want flexibility in their office leases now, Damiani said. They want the rights to expand, terminate, contract and extend their leases, he said. This makes sense: There is still plenty of uncertainty in the economy and office sector.
Damiani said that he also expects developers to continue to convert outdated office space into new uses, such as hotels and apartments. Fewer tenants are going to be satisfied with Class-C office space, Damiani said. Transforming this space into other uses might be the only way to fill it, he said.
“It used to be enough to upgrade the paint and furniture in these older buildings,” Damiani said. “That doesn’t seem to be working now. It’s hard to get people back into the office if you are not providing the best experience possible for them.”
Spec suites have become important to the downtown, too, Barrett said. Many building owners in the CBD offer fully furnished, often high-end, spec suites that are good options for smaller to medium-sized companies.
The suites range in size, but the ones most in demand are from 2,500 to 6,000 square feet, Barrett said.
“Especially when you look at the supply chain issues, these make sense for smaller to mid-size businesses,” Barrett said. “Companies can move in as they are or make slight adjustments. They have a move-in ready space, and that is very enticing. They don’t have to deal with architectural renderings, build-outs and waiting six to eight months for the space to be completed.”
A brighter future?
What will the future of office work look like? That’s not an easy question to answer. But Krosschell said that so far, most companies in the Twin Cities, and across the country, are running hybrid schedules, letting their employees spend time in both the office and their homes.
Workers might come into the office when they need to collaborate with their peers, but might work from home when they are doing the type of busy work that they can do in solitude.
Krosschell said that Avison Young’s research, which relies on cell phone and vehicle traffic data, shows that workers in the Twin Cities office market are mostly coming into the office on Tuesdays through Thursdays and working from home on Mondays and Fridays.
“The activity is coming back to downtown,” Krosschell said. “Our CBD is different because we have the Skyway system. The streets are not nearly as active today as they were before COVID and the social unrest we saw. But people are starting to come back. There is also a great investment opportunity for investors who want to invest in buildings that might be more affordable today.”
Damiani said that the future of the office market is bright, despite the challenges that this sector faces today.
“Painful as this has been, this will make the office sector better in the long run,” he said. “Landlords will do a better job of listening to the firms they lease space to. Companies will do a better job of talking to their employees, asking them what they like about the office, about what makes them more productive. Some Class-B and Class-C buildings won’t be around. They will be repurposed. The rest of the office space will be stronger and better. We’re not there yet, but we are getting closer.”