Before the pandemic shut down businesses, a robust economy had powered a building boom, sending office towers skyward in urban areas across the United States. The coronavirus outbreak, though, has scrambled plans and sent jitters through the real estate industry.
Skyscrapers scheduled to open this year will remake skylines in cities like Milwaukee; Nashville, Tennessee; and Salt Lake City. Office vacancy rates, following a decadelong trend, had shrunk to 9.7% at the end of the third quarter of 2019, compared with 13% in the third quarter of 2010, according to Deloitte.
Developers were confident that the demand would remain strong. But the pandemic darkened the picture.
“There is a pause occurring as companies more broadly consider their real estate needs,” said Jim Berry, Deloitte’s U.S. real estate sector leader.
The timing is unfortunate for Mark F. Irgens, whose 25-story BMO Tower in Milwaukee opened in mid-April at the peak of the statewide lockdown in Wisconsin. A month later, a small fraction of typical daytime foot traffic was passing by as most businesses adhered to the governor’s stay-at-home directive, which expired last week. A restaurant that was slated for the ground level was canceled, and three potential tenants have delayed their plans.
Instead of showing off the building’s sparkling Italian marble floors and panoramic vistas of Lake Michigan, Irgens is worrying about who is going to pull out next and what type of corporate landscape he might face when the pandemic finally ends.
But he is not putting on the brakes. The BMO had been planned for five years, and he has leases to negotiate, investors to please, tenants to woo and loans to pay off.
“Development projects are different than making widgets,” he said. “You can’t stop; you can’t turn it off. You have to continue.”
Slowly, workers are filling their BMO offices. Managers, who were scheduled to report Monday, constitute about 15% of the building’s occupancy. Irgens thinks it will be the end of the summer before it gets up to 50%. Without a coronavirus vaccine, it may be year’s end before the building approaches a “normal” occupancy, he said.
Other developers around the country are also dealing with the fallout, especially for towers with Class A space, regarded as the highest-quality real estate on the market. In most cases, new buildings are not fully occupied, and developers were counting on a strong economy to do the work for them. For instance, the BMO Tower was 55% leased before the pandemic.
The question facing the owners of office towers is: Will anyone still want the space when the coronavirus crisis fades?
If the economic pain drags on, there could be long-lasting changes to the way people work and how tenants want offices to be reimagined, said Joseph L. Pagliari Jr., clinical professor of real estate at the University of Chicago’s Booth School of Business. Some of the changes — like more spacious elevators — could be costly to put into place, he said.
The pandemic could be a “pivot point,” Pagliari said, and that would be bad news for building owners. The office towers were designed to be “best in class,” he said, but the pandemic has suddenly made their most salable amenities — common areas, fitness centers and food courts — into potential liabilities.
The economic crisis could also spur high interest rates on debt, which would cause building values to fall, Pagliari said. That may happen even if the crisis diminishes in the weeks ahead.
“The current pandemic has raised perceptions about the likelihood and consequences of future pandemics,” Pagliari said. Developers who can factor in such events will gain an advantage, but any skyscrapers that are built with pandemic fears in mind are years away.
The prospect that workers may want to continue working from home does not worry John O’Donnell, chief executive of Riverside Investment and Development, which is developing a 55-story tower at 110 North Wacker Drive in Chicago. The tallest building erected in the city since 1990, it is scheduled to open in August and will be anchored by Bank of America. Other tenants include law firms, many of which are doing business from home.
“There is a need for collaboration, team building, common business cultures and a continuous desire to have social contact within a business,” O’Donnell said.
The building is 80% leased ahead of its August opening. One tenant signed for 40,000 square feet of office space at the height of the lockdown, which O’Donnell took as an encouraging sign.
The building is already being adjusted to meet post-pandemic needs, something O’Donnell said newer structures were better able to do. Amenities are being updated to be touch-free. And owners are talking with tenants about walk-through thermal imaging to monitor workers and visitors for fevers.
The pandemic will result in a demand for more office space, not less, said Paul H. Layne, chief executive of the Howard Hughes Corp., a national commercial real estate developer based in Houston. Developers will move away from the industry-standard 125 square feet per person toward roomier workplaces.
But others say it is too early to tell when demand for office space will return. Jamil Alam, managing principal of Endeavor Real Estate Group, said the situation would vary by city.
“There will be winners and losers,” Alam said, explaining that he thinks denser metro areas like New York and Boston, which have been ravaged by the coronavirus, could find their luster lost in favor of smaller markets.
Endeavor, which is based in Austin, Texas, has a portfolio that includes 15.6 million square feet of commercial real estate in cities like Dallas, Denver and Nashville. One of its projects, the 20-story Gulch Union, will be the largest office tower in Nashville when it opens in August with 324,254 square feet of office space.
Smaller markets like Nashville are well-positioned for companies wishing to pull up stakes from major metropolitan areas with higher density and costs, Alam said. Gulch Union has leased 27,000 square feet, and four more deals totaling 40,000 square feet are near completion.
“Deals are still being done,” he said.
There will be an appetite for urban, walkable, mixed-use office environments, Alam said, and changes will need to be made in buildings over time, like fewer touch points on handles and elevator buttons.
But projects that have not been started yet will be paused, said Chris Kirk, managing principal of the Salt Lake City office of Colliers, the commercial real estate brokerage firm.
“If you are a developer or landlord or CFO, you are concerned,” he said. “Everyone is feeling the impact.”
Salt Lake City is in a better position to weather the crisis than other markets, he added, because Utah has had fewer coronavirus cases than most states and has not been under a statewide lockdown.
And the city is experiencing a building spurt downtown. A 24-story Class A tower developed by City Creek Reserve, the development arm of the Church of Jesus Christ of Latter-day Saints, is scheduled for completion next year. The building, which will have 589,945 square feet of office space, is already 80% leased.
Salt Lake City has been averaging a new Class A office high-rise every decade, and the pace is increasing. Still, the pandemic might put the brakes on that.
“Anyone who would be coming out of ground speculatively now without the commitment has got to be thinking about their timing,” Kirk said.
Irgens hopes to ride out the pandemic and continue with other projects. In February, his company broke ground on a six-story building in Tempe, Arizona, and it is moving forward with a 235,000-square-foot Milwaukee office project that is 42% leased.
“My partners in my business are working really hard to figure out how to have business continuity, and it is really hard to do that,” he said. “Things are changing daily.”
