Coronavirus

After flocking downtown to woo millennials, offices might be moving back to the suburbs

Key Points
  • "Is office space going the way of retail in five years? That's what investors are really trying to understand," said James Farrar, CEO of real estate investment trust City Office REIT. 
  • After a wave of office deals in downtown districts such as Manhattan, activity looks to be picking up again in the suburbs – at least in the short-term. 
McDonald's opened its new $250 million headquarters in Chicago in 2018, after 47 years in the suburbs.
Source: McDonald's

It was 2016 when General Electric announced it was moving its global headquarters to a smaller space along the central Boston waterfront, away from the quiet suburbs of Fairfield, Connecticut. 

Then McDonald's in 2018 opened its glitzy, new worldwide headquarters in Chicago's vibrant Loop neighborhood, moving out of a suburban office park in Oak Brook, Illinois – joining Kraft Heinz, Walgreens and other Fortune 500 businesses in a seismic shift of corporate office space to downtown. 

And with each of these moves, there were perks: Millennial talent was more plentiful in these bustling districts such as the Loop in Chicago, where the nightlife and bar scene were also strong. Some companies, including GE, found tax breaks from municipalities when they positioned their offices downtown. And reliable public transit systems could seamlessly transport workers back and forth each week. 

But that was before the coronavirus pandemic hit. 

For weeks now, companies across the country have been adjusting to entire workforces working remotely. Many of these offices are sitting empty, if only to be frequented by janitorial staff and a skeleton crew of essential workers. Zoom video calls are replacing what would typically have been meetings in conference rooms filled with colleagues breaking bread. Recently, Jack Dorsey's Twitter and Square tech companies both said employees can work from home "forever." Google and Facebook, meantime, have told employees they can work from home until the end of this year. Many others are expected to follow suit

What was once a land grab for downtown real estate could pivot to be rush to the suburbs, where space is plentiful and social distancing is much easier to enforce. 

"Is office space going the way of retail in five years? That's what investors are really trying to understand," said James Farrar, CEO of real estate investment trust City Office REIT, which owns 66 office buildings in several major cities including Dallas, Denver and Seattle. 

"I think you will see more and more tenants leave the city," he said. "There will probably be more satellite offices, where people don't have to be downtown. There will be more part-time working from home." 

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And millennials, which are the generation born between 1981 and 1996, might end up driving this trend — again. 

Twenty-seven percent of adults in the U.S. are considering moving homes because of the Covid-19 crisis, according to a survey by the International Council of Shopping Centers, which surveyed 1,004 people over a 3-day period from May 22 to May 24. But an even greater 43% of millennials, within that group, are considering a move, the survey found. Many are looking to the suburbs and rural towns, it said. 

Meantime, new recommendations from the Centers for Disease Control and Prevention on safe ways for employers to reopen their offices say, among a number of measures: Workers should commute alone (no subways); desks should be positioned 6 feet apart; communal coffee pots and snack machines should be replaced with single-serve options; and windows should be opened to try to help regulate air flow. 

The CDC is also recommending elevator use be limited. 

That particular guideline does not bode well for towering office buildings such as those found at Related Cos.' Hudson Yards development in Manhattan, which is still not fully leased but has already signed on office tenants including Facebook and Amazon. (Twenty flights of stairs, anyone?) 

Still, experts agree that a permanent work-from-home setup is not ideal for many. 

"It's not working from home that people want to do forever," said James Ritman, executive vice president and managing director at commercial real estate service firm Newmark Knight Frank's Connecticut office. "I think the big thing is, people who have commuted in the past are saying, 'I can be a lot more productive if I can work closer to home.'" 

Ritman said he has already done two so-called coronavirus office deals in the suburbs of Connecticut. One is with a company that had an office lease expiring in New York City, he said, that had not been contemplating getting a space in Connecticut prior to the Covid-19 crisis. Another is with a business that signed a short-term deal on an office space for workers that live nearby, to see how it pans out, he said. 

"Having these satellite offices is starting to make more sense," Ritman said. 

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As Ritman gives tours to prospective clients around Connecticut, he said companies are looking for ample parking space, as opposed to being near a train stop, which had been a top perk up until the pandemic. Companies are also looking for office spaces on the ground floor — to avoid having to use an elevator. And having outdoor space is also important, Ritman said. 

The downturn appears to have already started. Nine of the 10 largest office markets in the U.S. recorded increases in vacancy rates during the first quarter, which ended April 1, according to commercial real estate services firm CBRE. Downtown vacancy rates increased by 30 basis points, while suburban vacancy rates were up just 10 basis points, it said. 

"You're definitely seeing more tenants coming out of the city looking for suburban space," said Spencer Levy, chairman of Americas research at CBRE. "But let's be clear about what they're looking for. Smaller space ... and shorter-term space." 

In Manhattan, office leasing volume dropped 47% during the first quarter, compared with a 10-year quarterly average, according to a separate analysis by real estate firm JLL. 

One activist investor is already betting against some of the biggest office owners in New York. 

"In the midst of the pandemic, many companies have begun to question the need for physical office space at all, as the necessity of work from home provides a real-time and real-life look into a potential future with fewer workers in offices," Jonathan Litt said in a memo posted on the website of his hedge fund, Land & Buildings Investment Management, dated May 6. 

He estimates New York City office vacancy rates will top 20%, calling out office owner Empire State Realty Trust as bearing "the full brunt of this storm." 

Litt, who has previously picked battles with the high-end mall owner Taubman and has urged the department store chain Hudson's Bay Company to find ways to unlock the value of its real estate similar to Macy's, has a short position in the company. The REIT's shares are down more than 51% this year. 

Empire State Realty did not immediately respond to CNBC's request for comment. 

"As firms reduce headcount and cut costs to weather the recession, office real estate will be at the top of the list to shed, and the pandemic concerns will be a convenient scapegoat," Litt said. 

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