Waiting for the Ball to Drop

Photo: Jason E. Kaplan
Craig Sweitzer, founder of Urban Works Real Estate

Commercial real estate experts say a leasing boom is around the corner.

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There is a quote regularly misattributed to evolutionary biologist Charles Darwin that goes: “It is not the strongest of the species that survives, nor the most intelligent, but the one that can best adapt to changes in its environment.”

The quote was actually spoken by Leon C. Megginson, a management and marketing professor at Louisiana State University. But it holds just as true for business as it does in the jungle.

For commercial real estate agencies, COVID-19 has meant a year of seismic shifts, and paying close attention to industries as they adapted, or failed to adapt, to the new economy.

Although the market slowed to a crawl at the start of the pandemic, the last two quarters have seen an uptick in leasing agreements as companies and consumers adjust to a new era of remote working and online ordering.

Businesses require less office space than they once did, and proximity to residential areas has become more valuable. New restaurants and retail businesses have begun setting up shop where others have failed. But many in the commercial real estate market believe the most exciting times are yet to come.

As federal stimulus money dries up, vacancies will force landlords to lower rents, and an era of new business ventures could begin.

Nowhere has the COVID-19 realignment been felt more than in downtown Portland. The Standard Insurance Center, whose golden siding and black windows have been a fixture of Portland’s skyline since its completion in 1970, was home to 2,000 Standard employees until the pandemic.

Now nearly all of them either work temporarily from home or out of the company’s smaller office in Hillsboro.

The Oregon Community Health Information Network put its 40,200-square-foot headquarters on the market in August 2020. Last June vacation rental firm Vacasa sought to sublease 37,000 square feet of office space in its Pearl District RiverTec office building.

“This is the greatest real estate earthquake we’ve ever seen,” says Craig Sweitzer, founder of Urban Works Real Estate in downtown Portland. “Portland picked up 2 million square feet of vacancy during the pandemic, and that’s going to take a long time to absorb. Commercial real estate is a slow-moving thing.”

Total office availability in Portland increased to 20.2% in the first quarter of 2021 compared with 18.2% in the previous quarter, according to commercial real estate services firm CBRE. More than 1 million square feet of additional office space is in the development pipeline for Portland.

The advent of remote work has meant large companies do not have the office needs they once did. But office spaces have not seen the same drop in price as they did during the Great Recession, when Sweitzer says he saw office-leasing valuations drop by nearly 20%. What he has seen are landlords becoming more flexible, offering shorter lease terms as companies assess office needs.

“It’s the larger companies that are changing the most,” says Sweitzer. “They are saying to themselves: ‘We’re still profitable but we don’t need an entire building. Maybe we just need two floors and more satellite offices.’ That changes everything.”

The exodus from traditional office spaces has been most pronounced in the Portland metro area, where the pandemic’s economic downturn was amplified by civil unrest, lack of tourism and an increasing homeless population. But the trend has been felt across the state.

“There has been a real lack of leasing activity. People have hit the pause button and are signing short-term leases because office needs are going to change in the not-too-distant future,” says Jay Lyons, partner and principal broker at Compass Commercial in Bend.

“People are thinking COVID is in the rearview mirror, but there will undoubtedly be long-term shifts in how office space is being used. I don’t see our vacancy rate going through the roof. We’ve seen very few companies send everyone to work from home — but over the last two quarters, our vacancy rate has plateaued.”

Lyons and Sweitzer both observed that businesses in or near residential areas have performed well financially compared with businesses in commercial districts.

Another trend accelerated by the pandemic is the rise of so-called Zoom Towns — picturesque, residential cities like Boise, Idaho; Boseman, Mont.; and Bend, Oregon; which have become more attractive to employees who are newly remote. An influx of professionals into these areas have made those markets suddenly hot.

The solution to downtown Portland’s vacancy problem — and to a lesser extent, vacancy issues in other downtown areas — could be more mixed zoning. But doing so would require time, energy and commitment. “For that you need a strong development commission, and you need a strong city council. You would need to build workforce housing and homes for people with low income. Downtown Portland has never had enough housing. We need it now and we needed it 10 years ago,” says Sweitzer.

For many businesses, adjusting to COVID-19 conditions proved impossible. Shared workspaces were dealt death blows. In addition to losing half its occupancies and $3.2 billion in 2020, WeWork closed its Portland U.S. Customs House location. The Broad — a locally owned, shared workspace for women-owned business —also shut its doors.

Other sectors, particularly industrial real estate, have remained relatively unaffected.

One area where there has been enough activity to keep commercial real estate agents busy is the restaurant industry. Eateries that were unable to survive the pandemic are now being leased to restaurants that run a high-volume delivery operation — a phenomenon known in the industry as plug-and-play.

Commercial real estate prices have yet to drop despite the increase in vacancies and a permanent decrease in demand for office space. The large federal response to COVID-19, through stimulus checks and the Paycheck Protection Program, has staved off closures that may eventually come to pass.

“I think we are actually going to see a lot of pain coming down the pipe. Government intervention has only pushed it back,” says Matthew Bassist, director of NAI Elliott’s Portland office.

“You have the investment market that is still out of equilibrium. You have sellers who would entertain selling assets, but they don’t want to factor what’s going on in the leasing market,” says Bassist. “Work from home isn’t going to leave us. When people stop being able to float, what happens then? That’s going to be the $64 million question. Or more like the $64 billion question.”

There has been no shortage of ideas for how investors could use COVID-19 vacancies, if and when prices decline. Urban farms, high-tech agriculture operations that grow produce without the need for soil, could move into empty office floors.

Showrooms for companies like Amazon, which give customers an interactive experience with products before they order them online, and mini logistics warehouses could replace more traditional retail venues that can no longer survive on foot traffic alone.

But for any of this to happen, commercial real estate prices would have to get low enough that investors would take a chance. So far that has not happened.

“Once businesses start taking up less space, there’s going to be a drop in the market, and that’s when investors start to get excited,” says Bassist. “I think we are about to see a renaissance.”

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