By Jon Septer
The pandemic’s profound effect on the way people utilize space has led Minneapolis’ most dynamic real estate professionals to focus on opportunity amid uncertainty. Despite geopolitical turmoil, economic uncertainty, inflation, and rising interest rates, the future of the commercial office market will be determined by investors’ willingness to incorporate flexibility into leases as employers struggle to understand the long-term evolution of the hybrid work environment.
I recently had the privilege of hosting a discussion with three esteemed veterans in the Minneapolis real estate market to discuss this topic: Paul Donovan, executive director at Cushman & Wakefield; Jessica Mogilka, executive vice president at JLL; and Andy Babula, director of the Real Estate Program at the University of St. Thomas Opus College of Business. Finance & Commerce hosted the discussion.
The current environment—no surprise to anyone—is one in which tenants are in the drivers’ seat, demanding increases to tenant improvement allowances and flexibility in lease terms. Successful landlords are planning to identify ways to support a hybrid work environment, including temporary work spaces and expansion or contraction options within leases. These trends are not likely to change anytime soon. Donovan estimated that vacancy rates will rise to as high as 30% from the current level of approximately 24%. Mogilka agreed, saying, "Huge campuses are going to be reimagined; downtown spaces are going to have to be either flipped into residential or something else…Over the next 24 months, it’s going to look really scary for a lot of office (landlords)."
One thing is clear: We can't talk about the future of commercial real estate without talking about the future of in-office working.
'The desire path'
We've all seen it: the worn trail cut through the grass or ornamental bushes depicting the traffic patterns of pedestrians desiring a shortcut—often with a paved pathway just a few inconvenient steps away. Architects and city planners call this a "desire path." As Babula put it, people are going to do what they're going to do—and that applies to employees who’ve become accustomed to working from the comfort of home. Despite encouragement, incentives, and even demands from employers, many workers are emphatically refusing to return to the office. Others are undecided—not surprising, considering that the long-term implications of a primarily remote workforce on company culture, professional growth and mentoring, work-life balance, ability to perform amid a crisis (read: economic downturn) are simply unknown.
Meanwhile, in a tight U.S. labor environment, employers are increasingly sensitive to the risk of losing talented employees, and the smartest ones are also pausing to think strategically about how to plan for space needs while considering corporate growth, employee connection, and culture—the bigger picture.
Coffee and conversation
Similar to landscapers who reluctantly pave over the most persistent of “desire paths,” successful landlords are beginning to adapt to tenant downsizing by identifying creative ways to increase the quality and efficiency of space with enhanced common areas, while also affording tenants lease flexibility.
Nurturing connection is an important consideration. Last year, the Wells Fargo Center in downtown Minneapolis debuted a popular new feature for its tenants: the Reserve. The common area amenities include a modern fitness center and locker rooms, pool table, televisions, countertop seating, and free gourmet coffee and kombucha, and it is tastefully decorated with modern, attractive living-room-style seating areas and reservable conference rooms. The coffee itself is so popular that tenants now routinely complain about the lines, Donovan noted, but it brings people together. Little things like that provide value. "I think that's a lead investment for anyone," he said.
And Wells Fargo is not alone, Donovan added. "Landlords are giving higher concessions—in 22 years the highest concession packages I’ve ever seen."
Still, tenants are looking harder than ever at their space options. Some companies are vacating large amounts of space in favor of a hybrid work environment. Some are considering hoteling or co-working options like WeWork. Many are opting to put off leasing decisions if they can, Mogilka said, because it's impossible to predict the long-term impact of the hybrid workplace. "I see very few of my clients saying, 'We know exactly what we’re doing and this is how we’re going to do it,'" she said. Her tenants are also looking for opportunities for flexibility, many opting for a spec suite, or space that is move-in ready, over building out a custom space.
Her advice: talk to your employees. "We always start with that bigger workplace strategy, that visioning."
There was much more to our discussion. But the bottom line is that, while the pandemic has brought change to the commercial real estate market, it has also pushed us to reevaluate what we and our employees want from work—which is always a valuable endeavor.