Guernsey :Going back to the office is dead … Or is it?
For the past year the ‘Office is Dead’ narrative has rung loud. In the early days of the pandemic, many predicted that a post-COVID world would usher in a new normal, which would include permanent remote working arrangements and result in a wasteland of empty desks, offices, and buildings.
Predictions are easy to make, but what is the reality as the Covid economic freeze begins to thaw? Is the dead-office prophecy a reality?
From where we sit, the office market has been revving back up after the brief recess caused by the pandemic.
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While the office vacancy has doubled since 2019, from 3.6% to 7.8% YTD, it is a) an expected shift given the pandemic’s impact on the economy, and b) not too far from the normalized/equilibrium vacancy rate of 5.0%. In 2009 and 2010 (the peak of the financial crisis), the average office vacancy in our market hovered at 12.5%. Our current rate of 7.8% pales in comparison to the rates that followed the 2009 crash.
Vacancy rates aside, a look at the sales data reveals a strong 2nd quarter for the office segment. To date, 2021 sales volume for office in the Fort Collins/Loveland market is $50M across 44 sales, with $36M of that in the 2nd quarter. Prior to the pandemic, the highest sales volume produced per quarter in the office segment was around $33M in Q1 2020. In fact, Q2 of this year shows the highest volume in one quarter since 2015. In short, office sales volume is healthy.
Why on the heels of a pandemic, in which many companies abandoned their office lifestyle, would office sales be on the rise? A few possible explanations follow.
One of the more obvious reasons for a spike in sales volume is the continued low interest rates available to borrowers. The rates as we’ve seen them lately have made it substantially more affordable to be an owner occupant than to lease. Some bar napkin math can illustrate this. Take a 5,000 square foot property with a conservative $15/sf lease rate, equating to a monthly rent payment of roughly $6,250. Contrast that with a 5,000 square foot property purchased at $178/square foot, conventionally financed at a 75% loan-to-value (LTV) with a 4.5% interest rate, and the monthly debt service obligation averages $3,700.
The example above takes into consideration conventional commercial financing, and doesn’t factor in the extraordinary SBA financing opportunities now available to owner occupants looking to invest in real estate for their business. With terms like 90% LTV, interest rates in the 3s, and fixed rates for 20+ years, business owners who have leased for years not only find the prospect of owning their own real estate affordable, but also a way to shave their occupancy costs.
Lastly, recent tax legislation put in place by the Tax Cuts and Jobs Acts (TCJA) allows for preferrable tax treatment for real estate owners, adding even more incentives to own. The rules surrounding bonus depreciation enhance the value that a cost segregation study can provide using accelerated depreciation for tax savings. These changes also allow bonus depreciation for used property, which was historically not allowed for anyone other than the original owner/taxpayer. TCJA tax legislation increases the benefits of ownership for investors and owner-users alike.
So the recent market data provides an early indication of a strong recovery for office space in the northern Colorado market. This evidence on a local level is amplified by a few small companies like Apple, Facebook, Google, Twitter, Bank of America, JP Morgan…recently issuing calls for employees to return the office.
Now its our turn to issue a prediction for things to come. Absorption will continue its positive trajectory, with demand driven by an overall economic recovery. With nearly no new office product being constructed through the pandemic, existing office space should be poised for strong performance for the foreseeable future. But again…predictions are easy to make…we will see what the future holds!
Josh Guernsey is a commercial broker with Waypoint Real Estate in Fort Collins. He can be reached at 970-632-5050.
