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Tuesday, February 10, 2015

The Future Commercial Office Market, EntreWorks, January 2015

In its January newsletter, Entreworks of Arlington discusses the future of the office market, especially in the Washington, DC, region as a member of a county task force focused on the county's future office market.  The article begins by providing some important context:
Today, that once robust (note:  Arlington County) commercial office market is reeling.   Countywide office vacancy rates are at 21.4% and are even higher in certain submarkets. (National vacancy rates were roughly 14.5% in late 2014).   In the view of county leaders, a government spending downturn was only part of the story. Something bigger was underway and our task force sought to figure it out.
The Changing Demand for Office Space
As we began our work, the task force quickly recognized that the market demand for commercial office space was changing.  New kinds of companies---technology and high growth entrepreneur-driven ventures---are seeking to locate in denser urban and suburban markets.  Similarly, traditional anchor tenants, like law firms or government agencies, are downsizing.  Meanwhile, new ways of working, such as telecommuting and hoteling, are affecting all kinds of companies.   The bottom line is that potential tenants want less space and they want new kinds of workspace.   
The impact of these new preferences is quite pronounced.  In 2000, the average office in the DC Metro area provided nearly 200 square feet (sf) per employee.   Today, that average is about 185 sf per worker.  Certain tenants, like law firms and many government agencies, are cutting even further, reducing their space needs by nearly fifty percent. . .
Companies want less space; they also want different space.   Flexibility is their most pressing demand—they abhor long term leases that lock them into large spaces.   They want shorter leases, more flexible work space, and the ability to expand or reduce space demands as needed.   The anchor tenants who sign a long term lease for large swaths of space are becoming rarer and much more desirable.
They are being replaced by more and smaller clients that want it all—flexible leases, cool spaces, lots of amenities, and the like.  But, they may not be able to pay a lot for it—at least for a long and extended period of time. . .
Even with some griping, these new office structures look like they’re here to stay.  They save energy, they reduce costs, and a good share of employees, especially millennials, like them.  So, a period of adjustment is upon us.   First up is the commercial real estate sector that is scrambling to adjust to the new realities.    As the Deloitte analysis predicts, 2015 and beyond will be focused on redevelopment, where key players allocate “resources to newer formats and design for redeveloping existing properties” in response to lower levels of tenant demand.
Economic developers will also need to adjust.  Adjustment number one focuses on the broader question of tax revenues.  Jurisdictions that rely heavily on property taxes to finance local government must pay close attention.   Nationwide, property taxes account for 35% of state and local government revenue.  This represents the largest source of local revenue so large scale declines will be felt.
Second, economic developers and real estate professionals will need to help support a new “product mix” when it comes to commercial office space.  Aligning available space to various business life cycles may make sense. . .
Instead of making hard (and perhaps misguided) predictions on the nature of the future office market, we opted to develop some basic principles that are likely to guide the evolution of our office market.   Some of the principles are unique to the DC Metro area (e.g. “Reframe the Federal Presence”), but a number of them have relevance for all communities.  A few highlights worth considering:
  • A New Paradigm:  As tenants begin to prefer mixed use over traditional single-use office settings, economic developers must actively assess previously set aside space for office development and consider other uses or mixed uses (e.g. entertainment, live-work space) as well.
  • Grow the Pie:  Office space initiatives should be linked to entrepreneurial development efforts.  Develop “step out space” for firms that have the potential for growth.
  • Activity Attracts Investment:  A nice building is no longer sufficient.  Firms and workers want amenity rich urban environments, so effective place making goes hand-in-hand with successful commercial office development. 
  • Mixed Use Inside and Out:  Mixed use needs to occur in neighborhoods and inside buildings themselves.  Desirable office spaces combine workspace with play space and even living space.  Expect to see more live-work spaces in the future.
  • Connect Everything: Successful markets will have interconnections across all forms of infrastructure, with special focus on multi-modal transportation options and world class broadband connections.
This shifting office market is not just about real estate—it’s part of a wider transformation of work now underway and part of a larger constellation of forces that also includes the rise of the 1099 or freelance economy and the emergence of new on-demand ventures like Uber and AirBnB.   How we work, where we work, and what companies look like are now in flux.  This will create many challenges, but also more opportunities for communities, firms, and individuals that effectively handle the transition.
Click here to read the rest of this article and to link to the work of Arlington County's Future Office Market Task Force. 

Unlike Fairfax County, which officially rejects the notion that the office market is changing and has drafted an economic development strategy embedding the old office market economic model as a foundation for county economic success, Arlington County is taking a serious look at its commercial real estate future.  The difference reflects the excessive influence developers in Fairfax County have in shaping our communities.  In fact, the Arlington results are consistent with what Reston 2020 has been saying for nearly two years:  office size is shrinking and will continue to do so.  It goes further and suggests what that future space may need to look like. 

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