Return to Office Will Change the Housing Market (Not How You'd Think)

Over the last couple of months, we've seen a lot of major employers call employees back to the office full time. But the data also tells us that employees are reluctant to return and there are a lot of hybrid situations developing as well. What does this mean for the future of work and how does this translate to demand for housing and for apartments in the areas that there are a lot of offices? Today's expert shares his insights. Hey friends, welcome to On The Market, the real estate news and economic shows for investors and real estate professionals like you. Today, I'm here with Matt Reedy, a director of commercial real estate economics with Moody's Analytics. Matt's research has led him to an insight around a specific type of office property that is still performing really well. And I'm also super excited to talk to Matt about how the activity in the office sector is translating to demand for residential properties. And I'm not just talking about residential multifamily and what's going on there. I'm just talking about how this is changing where people want to live. For generations, people wanted to live close to where they were working. The pandemic upended all of that and the return to office trends have implications for whether the shift to the suburbs is going to continue or we'll start to see more demand back in downtown areas. We'll get into that and a lot more in my conversation with Matt. So let's bring him on. Matt, welcome to On The Market. Thanks for being here. Thanks, Dave. Happy to be here. I'm excited to talk to you about this return to office situation going on because we've been hearing about this for years. You know, ever since the pandemic started to wind down, you know, two years ago, people have been saying return to office is happening but it sort of feels like it happens in fits and starts like where there's just like a wave and then you don't hear about it for a while but it feels kind of like we're in a wave. There have been a lot of pretty high profile companies have been calling people back to the office recently. So what do you make of that? Is that actually happening or is that more just headlines? Let's start there. Well, I mean, yes, I think it is happening or will happen. A lot of the policies that have been announced from companies like Amazon, you know, don't take effect until after the new year. So they haven't quite started going back into the office full-time yet but even with the announcements that you hear, the majority of companies out there are still settling in on a hybrid type of structure where they're in the office two to three days a week. Okay, and you said it will keep happening. Why do you say that with such confidence? Well, I just think the further we get away from the pandemic, the more companies are going to push to try and get people back into the office. It seems to be that a lot of CEOs, for one reason or another, like to have people in the office and there are obviously some benefits of being in one collaborative working space and being able to just pop your head into the next cubicle or the next office to ask a question. So will we continue to see where all companies go to five days a week in the office? No, I think the hybrid work structure is here to stay. Got it, okay. And I think just for our listeners, this has a lot of implications for real estate. I think in two primary ways. The first is office utilization. We've heard a lot about how offices have been vacant, values have been plummeting. That's have all these sort of secondary implications for downtowns and cities. The other thing is that over the last couple of years, we've seen the suburbs really explode in terms of demand for housing, both single family homes and for rentals because people are less tethered to these historic economic centers like San Francisco, New York, Chicago, all these, LA, all these places. So I wanna explore each of those, Matt, but I think let's just start with a more direct implication, which is office space. Have we seen an uptick in office utilization because of these policies? We have, and there's several different sources out there for office utilization data and they measure and record things different ways. Some measure it by badge swipes or security badge swipes. When you enter the building, some use cell phone tracking information to pinpoint the data. By most metrics, we're at post-pandemic highs for utilization. Now that said, it's still well below where we were prior to the pandemic overall. And Matt, what about, you know, those are sort of measurements of leased office space. How often is it getting used? But are we seeing an uptick in occupancy of offices? Yeah, we've seen positive absorption for the last month or two, which is where more office space becomes occupied than becomes vacant. So we have seen a little bit of an uptick there. Vacancy hit, in our data, hit an all-time high at just over 20% in third quarter. In October, ticked back down just a little bit, but we are sitting at all-time highs or very near all-time highs in office vacancy. Got it, okay. And what is the outlook in the industry? Is the expectation that we'll see some relief? Because from everything you read, it just seems like office is still, no, I wouldn't say a free fall, but it's sort of settled in at this much less attractive values for investors. Yeah, and I would say from an occupancy standpoint, we think we're nearing a bottom if we're not there already. We may see a little bit further uptick in vacancy, but it won't be significant. The bottom line is we still have office employment growth and construction has slowed immensely in office where there's far less new office space coming online. So the combination of continuing to see office employment growth along with that drop in construction, you'll see some positive absorption, which will hold the line if not start to bring the vacancy rates back down a little bit over the next couple of years. But we're not calling for like a strong recovery in office either. Yeah, right. I don't wanna give that impression, but yeah, sort of a slow leveling off and maybe start to see a little bit of a turnaround. And of course this, I assume Matt is regional, right? Like we're talking, what you've said so far is on a national basis, but I would imagine that there's significant regional variance here. There is. And when we're talking about return to office for at least two days a week anyway, New York and Miami are sort of leading the pack from a return to office standpoint. Finance, basically, sort of like finance hubs. To a large extent. But one of the things that we've seen that's more emerged as a pattern that we would expect to continue is a divergence between class A office space and lower quality class B and C office space and the divergence between downtowns or central business districts and suburban. Okay. Can you tell us more a little bit about that second part? Because I wanna ask about class A and class B, but our audience here is mostly residential real estate investors. And so I think this divide that you're alluding to between downtown and suburban office space has big implications, even for people who don't invest in office. So can you tell us more about that? Basically, the thought behind it is a lot of companies are trying to entice people to come back into work. And the two biggest levers they have to pull to get people to come back in voluntarily at least are to step up to much nicer office space. That's the class A part that we can dive more into. And then the other piece is having offices closer to where they live. And I often make the joke that the top two things that people hate about coming into the office are the commute and having to spend time with their coworkers. And you can fix one of those. Now, in all serious note though, the commute part of it is important. And having the ability to have an office closer to your home in the suburbs counts a lot for that. The other piece is a lot of times suburban offices tend to be smaller offices that are more service oriented. So you tend to have a lot of lawyers, CPAs, insurance firms, other things of that nature where they're just much more attuned to being in the office or they have to be in the office really to service their customers. That's why we've seen suburban office outperform central business district, and in particular, the class BC in central business districts. For me, it's hard to imagine, and I'm sure it will happen eventually, like what demand there's going to be for class C and B office space in downtown areas. Of course, there's certain markets where it's going to be popular, but I tend to agree that hybrid, at least for more of the traditional office type jobs is probably going to be here to stay. And like you said, no one wants to go into an office two or three days a week to be in a dated facility in an expensive downtown area where it's hard to park and it's hard to get to. And I wonder if construction will start being elsewhere and demand is just not going to come back to those areas. Yeah, I mean, that's certainly what we've been seeing on class B and C in central business districts is that the demand is just not coming back. Frankly, what we would expect for the reason that you said, if you're going to go through the trouble of commuting to downtown, pay the expense of parking, the last thing you want to be doing is sitting in an office where you've got two foot by two foot windows every five feet and no natural light and very dated. Technology support in the office isn't great. It's difficult for the company to manage, et cetera. So we really look for a lot of those properties to be at some point taken offline. Oh, interesting. All right, so there's this fundamental shift in both total office space occupancy and where offices are getting leased. But I'm also curious about some of these downstream implications of this phenomenon. Like what does this mean for surrounding housing markets? And we'll get into all of that right after the break. Hey, friends, welcome back to my conversation with economist Matt Reedy. So, yeah, I mean, we've talked a little bit about office to residential conversions on this show. I, you know, at this point, it does feel unrealistic that that's going to happen in mass. Maybe that will change if there's some sort of public private partnership. But I think for the purposes of this show, I'd like to focus more on maybe some of the sort of secondary effects of office decline. So we just talked about, you know, how some of these places, demand's not coming back. What does that mean for downtowns in general, not the office space, but for the residential demand or maybe retail? Yeah, I mean, clearly it's not a great sign for those things. But yeah, and again, not to focus too much on the office to residential conversion, but that is one solution for some of this office space. But again, we actually have seen a bit of an uptick in occupancy in class A office space in central business districts. So the demand there has still been fairly strong from a number of occupied square feet. We're above where we were prior to the pandemic for class A office in central business district. So I think that will continue to support those downtown areas. And we agree it won't be on a large scale, but you will see some conversions. And we have seen some conversions of those class BC to multifamily. It just sometimes takes a lot of creativity to get that done. Best example of that is 180 Water Street in New York, where they literally cored out the center of the building for all 20 stories and turned it into basically like a block O for any Ohio State fans out there with a central courtyard. And then because of what they cut out of the middle, they were able to add additional floors on top of the building under New York's floor area ratio laws. That's so funny. So they actually added a few floors at the top of the building. Really interesting project. This was many years ago, but I lived literally across the street from that building when I was in college, when I had an internship there and lived in an NYU apartment there. But I digress. So I think that that is sort of an option, but it's super expensive, it seems. And like doing projects like that are more one off at this point than being done at scale. It seems risky to me. Like, I don't know anything about what this really takes, but it does seem difficult and risky. So I guess I'm just curious about what this means for the housing demand in these areas, because if demand for this office space isn't coming back, does that mean places, downtown areas are going to struggle in terms of rent appreciation, in terms of home demand? Because people won't want to live in these traditionally more expensive areas if they're not going to work nearby. I think you're right. The less office space there is downtown, the less demand there's going to be for retail and residential. And to the extent that you see a decline in that office space, yes, that will present issues. Now, when we talk about underperformance of the Class B, C in central business districts, I wouldn't say that it's of a magnitude that we would have all that strong of concerns about downtown areas. And it's really, it's been a long term cycle for Class B, C in particular. As far as the number of square feet occupied, we're somewhere in the neighborhood of just over 90% of where we were coming out of the financial crisis. If that gives a little bit of an idea of the scale, probably about a 10% drop really over the last 15 years in occupancy of Class B and C, or I should say occupied square feet. I just make that distinction because occupied square feet can go up while the occupancy rate still drops if there's more construction that comes online. So when we're just looking at the number of square feet that are occupied in Class B, C, it is down, but it's not down to an extent that we would say that it's going to decimate downtown areas. I'm glad you said that because some of the data I've been looking at seems to suggest that some of these areas that people assume have been hollowed out by the pandemic and this office flight are actually seeing some of the strongest growth. Like New York is a great example. It did get hit harder than most during the pandemic. I mean, being in a really dense urban area like that was not very desirable during COVID and people left en masse, but now we're seeing the demand for apartments in Manhattan seems to be going up and the areas around New York are seeing some of the fastest home price appreciation in the country. And I don't know if this is true in some of the areas in California, but I think some of the same rhetoric was going on, you know, San Francisco, San Jose, even LA, like people were going to leave these markets, but it just doesn't seem like that's really happening. Yeah, I mean, we definitely saw some of that during the pandemic, but to your point, I think there's been some return to those areas, even San Francisco, where things got pretty bleak for a little while there with downtown office air. Yeah. You know, it has seen some strength, you know, primarily driven by large language models and artificial intelligence, where there's at least some pockets anyway in downtown San Francisco that have been very strong, even from an office standpoint. Yeah, I'm curious about San Francisco just because the AI boom is like just starting. And it seems like San Jose, Silicon Valley is going to be the epicenter of that. And in my mind, it seems like there's likely to be a rebound in that area. Yeah, and it's interesting because in my career alone, over the last 20 years, I think there's been three or four different big economic events that have caused people to say, oh, San Francisco, the Bay Area is dead. It's never coming back. And it reinvents itself with some new tech every time and bounces back and eventually surpasses where it had been before. And I think that's what you're seeing now with AI, is you're seeing that drive, that recovery. And to your point, I think it really is pretty early in that process or in that growth. Yeah. And I don't disagree about that being sort of the epicenter. So let's talk a little bit more about the suburbs, because this does seem to be a evolving dynamic that I have never seen in my career. And I think from the data I've seen is pretty unprecedented, which is that there might be a boom or a shift towards more office and working in suburban areas. So first and foremost, Matt, is this all a product of the pandemic or was this trend beginning prior to 2020? It was a trend that was beginning prior to 2020. Again, we track sort of the number of occupied square feet going back to 2009 and the financial crisis. And for almost that entire period of the four that I've referred to, class A suburban, class BC suburban, class A downtown and BC downtown, class A suburban has been the strongest performer for pretty much that entire period. And even from 2009 to before the pandemic, we had seen occupied square feet in those areas climb by 15% to 17%. Whereas now, since the pandemic, they're up another 2% to 3%. So not significant gains, but positive in the face of everything that's happening in the office market is pretty strong performance. Got it. Okay. And I don't know if this is too ambitious a question, but do you see a correlation between the creation or occupancy of office space in suburban areas and demand for housing around those areas? So we haven't done any specific, or I haven't, I'm not privy to any specific research on that topic. I know, I'm sorry. No, it's okay. I figured it was probably outside your purview, but I had to ask. I could probably ask one of my coworkers and get you an answer to it, for personal gratification or just to know what the result or the relationship is. I can't help but think that it would have some impact. Yeah, I would, I guess that's to me, your statement earlier about commute times just makes sense, right? I work remote and never working at BiggerPockets did I have a huge commute, but I used to commute over an hour each way. Now I commute zero minutes. I often genuinely put more time into work because of that, but it also gives me more free time and that is so valuable, right? If I could cut that down, if you could get an hour back of your day, I would have to believe that there's going to be demand for office. That's the whole reason there's demand in Manhattan, right? People want to live there. Obviously, there's a lot of cultural and fun stuff going on there, but mostly I would imagine the primary reason is because you're close to your job and it just creates this convenience. And that to me feels like there's going to be more demand. Yeah, I totally agree. And maybe again, now I'm just speculating because it's outside your purview, but it sort of to me feels like there's sort of this blending now between urban and suburban. And like now you see these sort of suburban areas where there's pockets of walkability and office space and mixed use development where it feels more urban, but just on a much smaller scale. And then you go a mile and you're in traditional single family zoning and that sort of stuff. And it makes me wonder if those things are going to continue. Yeah. And those live workplay type environments like that that you're talking about have tended to be the best performers over the last couple of years. Yeah. And where we've seen where we've seen the most demand and strongest rent growth, strongest occupancy has been where they're combining those different elements. All right. Time for one more break, but we'll be right back with Matt's insights for investors. Welcome back to On The Market. Let's jump back in. So, Matt, from your research, is there anything else you think our audience should know? Our audience of mostly residential investors, like how would you putting yourself in our shoes? Think about return to office. Think about the situation in office in general, in terms of helping guide portfolio and investing decisions in the years to come. Take a minute to think about that one. Please take all the time you want. We will edit it out or put in Jeopardy music. You know, I made it to the in-person auditions for Jeopardy at one point. Did you? That's so cool. But anyway, that's a whole different story. So back to the question, I think a couple of things that I would think about from the standpoint of, as an investor in residential housing. First and foremost, most sources will tell you, and we say the same thing. There's a shortage of single family homes or places for single families to live, whether it be homes or apartments across the country. Some markets might be a little bit oversupplied at the moment, but on the whole, we still have a shortage, depending on the source you look at of anywhere from one to three million single family homes. So, yeah, the demand is going to be there for single family homes and for rental property for the foreseeable future. Right now, it's really difficult to get construction projects off the ground as well. So supply, other than projects that were started a couple of years ago that may be coming online or close to coming online, the starts of new housing are lower than they've been in the last several years. So the demand is going to continue to be there. The supply is not likely to match what it has been in the last two years, call it, where we had just a flood of new apartments coming onto the market. So we think ultimately it's going to be supportive of rents and occupancy for rental properties and for single family homes as well. And I think that by the middle part of next year and into 2026, we'll probably be back into the three-ish percent rent growth area on rental units. That's the backdrop that I lay. As far as selecting from there or the impact that office, et cetera, is going to have on it, clearly where there's new development of those live-work-play type of environments, where there's a new office building with some retail component, maybe an apartment component, those areas are going to be desirable to live in and around. One, because there may be a good chance that somebody who's living in a single family home half a mile away is working at that office, but they also want to be near shopping, near restaurants, near other things. So I think that'll be sort of the focus or the epicenter of where you see the most demand and the strongest rent growth and occupancy trends. Well, thank you so much, Matt. I tend to agree with you. I think that's great advice for people. And in line with some of the other opinions that we've heard, and it is encouraging, I think for people who want to get into the market to hear that there's probably going to be rent growth. I think for me, this is just, I mean, my own selfish opinion, but I do think that this sort of shift to suburban investing does take some adjustment from an investor's opinion. When I started, it was just like, how close could you get to downtown? It was sort of, you know, for a reasonably affordable price. And there's still, that's still going to be true. Like, as Matt was saying, getting close to these economic engines, especially with return to office, is going to be important. But this sort of shift to a lot more suburban opportunity is exciting. There's a lot of opportunity there, but I think it's a little bit harder because you have to study and try and understand more than one just geographic area. You can't just like draw concentric circles around a downtown area anymore and say like, these are different price tiers and different neighborhood classes. But I do think it creates a lot of exciting opportunity for investors as well. Matt, thank you so much for joining us. This was super helpful conversation. Appreciate you being here. Well, thanks for having me, Dave. I enjoyed it as well. And thank you all so much for listening. We will see you next time for another episode of On The Market.