Key Takeaways

  • While there is a lot of conjecture about the fate of the post-COVID office, the property type has been able to avoid the worst of the recession thus far – largely due to (still) attractive underlying fundamental characteristics (tenant diversification, location, and longer-term leases). However, the property type may experience a significant demand shock in the coming periods and valuation headwinds if the recovery is not full and soon.
  • Demand for office space is likely to decline, given economic hardships faced by corporate tenants and due to the adoption rate (<100%, but greater than 0%) of more permanent remote or distributed employee base. Forecasts for offices being outdated or “a thing of the past” are overblown, companies will continue to find reason to have their employee base centrally located, however it might not be the entire employee base.
  • With decreased demand, lessee’s likely to have more power in negotiations. Lease terms may become more flexible, short-term, and accommodating to tenants. Capital sources for office investment will likely focus more on tenant risk and rollover risk, and will haircut “market” operating metrics for conservatism.
  • The pricing and valuation of office properties will likely see greater variance within each market, while the Largest MSAs may lose some of the premium that they have historically demanded over smaller markets. The low prices in major MSAs may be an opportunity for institutional investors to make opportunistic acquisitions and lead to greater consolidation.

Rocky start to 2020

The economic outlook continues to be in a muddled state. Key metrics and indicators of economic health appear to be improving gradually, but it is clear that the damage caused by the pandemic will not be reversed as quickly as it came. The silver lining of the situation is that while badly bruised, the economy is not broken. The current crisis sent wide-ranging shockwaves through the health, financial, and social system almost as soon as it arrived. These shockwaves unsettled the commercial property markets. Though the initial shock may be over, the speed and duration of the recovery is still not certain. This uncertain forward path is clouding the outlook for office properties.

In the first six months of 2020, the count of office transactions completed was down 23% compared to the same period in the prior year (3.4 thousand in 2020 vs 4.4 thousand in 2019). This decline was driven by a much slower second quarter, which was down 47% compared to the prior year. While this disruption is noteworthy by itself, the rapid decline in market activity and transactions also has challenged price discovery across the office market. In July, less than one third of office property transactions were proceeding on time.

Data overview

In this report we leverage over 535 thousand transactions of retail, industrial, multifamily, and office transactions across 336 MSAs. Each transaction occurred between January 2005 and June 2020, was greater than $500,000, and had more than 5 thousand square feet (10 thousand for multifamily). To observe differences in different MSAs, we grouped the MSAs by population size based on 2019 estimates from Census. The categories of MSAs by size include:

Largest MSAs: These are the 14 largest MSAs by population.

Large MSAs: These are 35 large MSAs, ranked 15-49 out of 336.

Medium MSAs: These are 48 medium MSAs, ranked 50-97 out of 336.

Small MSAs: These are 91 small MSAs, ranked 98-188 out of 336.

Smallest MSAs: These are 148 small MSAs, ranked 189-336 out of 336.

The data used in this report focused on office properties and excludes niche property types such as: medical building, medical condominium, and office condominiums.

In the first two quarters of 2020, the commercial property markets experienced significant disruption in terms of transaction activity, lending, and price discovery. When it comes to property types, hospitality was the first and worst hit, as travel limitations and state economy shutdowns halted operations and essentially eliminated any demand that was there. The next property type on the pandemic hit list was retail – which is still going through the pains of decreased consumer mobility and willingness to spend in store. While retail is far from dead, the accelerated shift to online and away from in-person purchases crippled many retail establishments and cast a grim outlook for the property type. Industrial properties benefited from the consumer’s shift to online retail resulting in an accelerated demand for distribution centers; the property type has also benefited from the expectation for more American companies to onshore and bring production back to the US. Government stimulus, transfer payments, and continued robust activity by the government-sponsored enterprises (GSEs) largely spared multifamily from the worst up until now – though, cracks are beginning to show in operating metrics and will likely continue to bubble up in the near-term (barring any major rent relief policy or additional stimulus), putting downward pressure on valuations. Finally, office property market valuation and transaction activity were negatively hit by the pandemic but fared better than retail and hospitality. However, as the lasting effects of COVID continue to shape expectations for post-pandemic life, the outlook for office dims on demand concerns.

Public valuations slide on uncertain outlook

The publicly traded real estate investment trusts (REITs) data reflect this darkening outlook. Office REITs have lost about a quarter of their value year-to-date (YTD). While this might not look as bad as the retail and hospitality YTD performance (-36% and -48%, respectively), what is more concerning is that the underperformance gap between office REITs and the broad market (S&P 500) and broad REIT market (FTSE Nareit All Equity REITs) is growing. At the end of April, YTD performance of office REITs trailed the broad market by 13% and other REITs by 6%. By the end of July, the underperformance nearly doubled as YTD performance of office REITs trailed the broad market by 25% and other REITs by 13%. (REIT sector data from NAREIT, as of August 14.)

When pandemic hit the US in the first quarter, many market participants saw the writing on the wall for hospitality and retail; by the end of March, retail and hospitality REITs had lost about half of their value. The challenges for office properties were not as clear right off the bat. Even when it was clear that the economic damage was not going to be reversed as quickly as it was caused, there were three key reasons why office property valuations looked as if they might be able to weather the temporary COVID-19 storm.

Tenant concentration

Office properties are used by nearly all industries, so the tenant base is incredibly diverse. Unlike the global financial crisis (GFC) which hit financial services particularly hard, the current crisis is not industry specific. While some industries are hurt more than others during this crisis, the common factor among those hurt more severely is the fact that the point of sale is in-person (e.g., walk-in retail, lodging) and not corporate offices.


Whether located in the central business district (CBD) or suburbs, most office property is located within close proximity to established population centers. Over the past decade, consumer preference (largely due to millennials) has been driving an urbanization trend across most large markets – densifying cities and decreasing commutes. These long-term trends are slow and powerful; so it is understandable that this trend would be expected to continue if the pandemic were short-lived.


The average life of most office leases is five to ten years. Reonomy Research looked at the 2Q 2020 reporting of 21 listed office REITs and found that the average lease term is 6.7 years. This means that every year only approximately 15% of leases expire – which is much more stable than other property types with shorter lease terms (i.e., retail, multifamily, hospitality).


After the initial shock in the first quarter, rent collections across office properties held up much better than those across retail and hospitality. But transaction activity remained muted and spreads on the debt side remained elevated. Many office property tenants were initially forced to adopt a remote work policy, but as they learned to conduct business with a distributed workforce, management teams began reassessing the necessity of their office space. Industry participants are split on the overall impact, with some envisioning the “death of the office” while others are calling for more modest changes in office space set up and use.

Historical context for office markets

A primary property type, transaction dollar volume for office properties has historically accounted for roughly a quarter of total transaction volume. Even though 2019 was a record year in terms of transacted dollar volume for the other main property types, office still was not able to surpass its pre-GFC peak (the only property type not to do so). The economic recovery and expansion which followed the GFC was the longest on record, which benefited office properties, however very gradually. Office properties appreciated in value at a constant rate of 3% per year for the last decade – which is not too shabby and right in line with retail properties – but well behind the appreciation seen at industrial and multifamily, 4% and 10% per year, respectively.

During the GFC, office was the first core property type (retail, industrial, multifamily, and office; excludes hospitality) to peak in terms of price – peaking at $121/sf in September 2007 and was the last to trough at $91/sf in June 2012. The peak to trough was a decline -24%, above the retail loss experienced (-20% between June 2008 and April 2011), but above the -25% drop experienced by industrial from September 2007 to November 2011 and almost half the -45% drop in multifamily prices between March 2008 and March 2010.

Despite the slow and steady climb from the June 2012 trough, the Largest MSAs continued to trade at a noticeable premium to Large, Medium, and Small MSAs across office properties of different sizes (>5k and <=20k, >20k and <=50k, >50k and <=100k, >100k sf). Between 2017 and 2019, the premium between the Largest MSA and Large MSAs for the same size building averaged approximately 25%, though it has decreased from close to 50% around the GFC.

What will demand for office space look like during a recovery?

Demand for office space will depend on the type and timing of the recovery. If the recovery is one which includes a scalable vaccine or therapy for the virus, then employees can return more fully to the office than a recovery scenario in which the health crisis is not fully mitigated. The timing of the recovery is also very important because as noted above, about 15% of office leases expire on any given year and those that expire during the pandemic are less likely to be renewed immediately either due to employers adopting a greater degree of remote work or due to budget constraints and financial events (i.e., bankruptcy, layoffs, downsizing). The typical company spends close to a tenth of its budget on its office space, so this is an area that will likely come into focus for expense reduction if the recovery is slow.

Given the potential cost savings and that employee productivity appears to have held up through the pandemic thus far, there is little urgency to bring employees back to the office before the health crisis has abated. Before the pandemic, many employers were competing to attract top talent from in an incredibly tight labor market – and comfortable and convenient office space in high price areas was one way to do so. However, now the labor market has plenty of slack, and employers likely do not have to compete with corporate digs and campuses.

More space needed?

Some industry participants have suggested that companies will be de-densifying the workplace and giving more space for employees. While we agree that a less dense work environment might be the end result, it is not because the companies will be increasing their office footprint. A less dense office space is more likely to result from fewer people being in the office at a given time. One of the most likely ways for this to happen is permanent adoption of remote work policies, even when offices are ready to fully re-open. These remote work policies will likely be limited to less than 100% of the time (e.g., 20% is working remotely one day per week). Employers will be incentivized to provide this option to employees because it can be presented as a work-life balance benefit and will also allow the company the flexibility to operate with less space. Some companies may take this even further and allow for a greater amount of remote work per employee, and provide flexible workspace for when their employees want to work together in person.

How might office leases change during the recovery?

Until the recovery is sure-footed, occupiers will likely push for greater flexibility in lease terms. Shorter terms with favorable renewal options and increased tenant improvements will likely be brought to the negotiating table. In many of the largest markets where lessors with high-priced office space have been able to set the terms for the past few years given tight supply, it will become a lessee’s market. Overall one should expect less effective rent growth under these conditions, which will translate to decreased net operating income (NOI) per square foot. At the end of 2Q 2020, Reonomy Research analysis found that office NOI across the nation was approximately $26 per square foot and could drop to $22 within the next twelve months. In an effort to put space to use, more office owners may seek alternative uses for their space – perhaps renting out at flexible work space or supporting increased subleasing activity.

What will underwriting of and financing for office properties look like?

Until the health crisis is under control, one can expect to see greater scrutiny of lease-up and rollover assumptions and a more thorough tenant analysis. Haircuts will likely be applied to market operating metrics from the recent past, as new dynamics will encourage capital sources to lean conservative. Rollover risk is major, especially for properties that have leases coming to term in the coming 12 months. Location will still be important for long-term financing, however in the short-term in-place rents and tenant quality will be the key factors for financing – at least until markets re-stabilize.

While the more conservative underwriting may mean that there is less financing available for office properties in the near term, this credit availability will likely affect purchases more than refinancings. Using the commercial mortgage backed securities (CMBS) data as a proxy, only about one in nine, or 11%, of loans backed by office properties matures before the end of 2021.

What will pricing look like for office properties?

All of the changes noted above – decreased demand for space, greater lessee negotiating power, and tighter financing – will result in lower pricing for office properties in aggregate and greater variance of similar products within the same market, driven by different current tenant and lease exposure. The longer the recovery takes, the more difficult it will be for the Largest MSAs to keep their premium pricing when compared to other MSAs. At year end 2019, the Largest MSAs were pricing approximately 25% higher than other Large MSAs and approximately 50% higher than Medium MSAs. Even though the Largest MSAs may lose some luster, the low prices in major MSAs may be an opportunity for institutional investors to make opportunistic acquisitions and lead to greater consolidation within a given office market.