The return to work has brought arguably more uncertainty than the initial transition to working from home, explains Steve Jellinek, head of CMBS research at DBRS Morningstar.

Uncertainty remains a key theme as corporate occupiers look to assess their current portfolios against their future office requirements. They must accommodate everyone who could be present in the building at any given time and must consider peak occupancy instead of average occupancy. A huge shift to hybrid work is abundantly clear for office and knowledge workers. Exceptions include buildings in high-growth markets, as well as life sciences and medical office properties.

Companies are prioritising the importance of office space and the result is companies are investing more in the quality of the space that they create, so that it can support the kinds of activities that are collaborative and require people to come together. An emerging norm is three days a week in the office and two at home, cutting days on site by 30% or more. Google was probably the most prominent, telling workers it wanted most of them back in the office three days a week starting April 4. Rather than bringing a huge drop in office demand, we see big reductions in density, not space. In another emerging trend, we see owners of some class B and C buildings experimenting with coworking models, turning to a flexible office space model on certain floors or throughout their entire building where pre-built suites and shorter-term leases are leased to tenants willing to snap them up.

Rents are a function of location and New York City is a good example. One Vanderbilt skyscraper just across from Grand Central Terminal, which opened in late 2020, is nearly entirely leased and commands some of the highest office rents in the city’s history. An office tower doesn’t have to be new to be successful, either. The one at 320 Park Avenue, built in the 1960s, hit 96% occupancy at the end of 2021, the landlords spent US$35m to US$40m on a modernisation program, which included new lobby, coffee bar and fitness center.

At the end of 2021, Manhattan’s highest office rents were being charged in the Hudson Yards district, where the skyscrapers are new and have all the latest bells and whistles. At the other end of the market, at about US$53 a square foot in average rent, was the City Hall area Downtown. Three submarkets, the other two being Penn Plaza and Times Square South and Downtown’s Financial District, were charging sub-US$60 rents.

Nationwide, on a year-over-year basis as of March, most markets are still above last year’s vacancy level, according to CBRE Econometric Advisors. Due to this, we believe that most markets are tenant friendly except for the tightest markets and premium spaces. We see this in the widening gap between asking and effective rents. Tenant concessions continue to increase, with landlords offering both rent abatements and higher tenant improvement allowances.

Flight to quality remains a dominant theme affecting market performance. Factors include enhanced amenities, health and safety protocols, and an expanded adoption of ESG. Because of this, we expect to see heightened competition for class A buildings, especially in markets with abundant new space such as San Jose, California, Austin, Texas, and Charlotte, North Carolina, where landlords have to compete more intensely to secure tenants that may be shrinking their overall footprint due to the rise of remote work.

After reaching a 14-year high in 2021, lenders and investors are taking a step back as acquisition and lending volume on office properties in CMBS has declined so far in 2022. CMBS issuance volume for office properties fell to US$6.8bn through mid-May from US$34.4bn for all of 2021. In addition to declining volume, loan size is up, and underwriting has become more stringent. The average CMBS office-backed loan size grew by more than 55% over 2018 even as the volume of loans declined. These larger loans boast lower loan-to-value ratios and tend to be secured by premium assets with strong sponsorship and superior locations. Average LTV declined for three out of the past four years, to 53.2% so far in 2022 from 57.4% in 2018.

Most corporate tenants are financially healthy and have continued to honor their leases, regardless of whether they are using their space or not. Cash flows have held steady and delinquencies on office mortgages remain muted. Rents and demand will eventually return to pre-pandemic levels, as the pandemic wanes and companies figure out how to navigate the new office landscape with different working models.