In A Bid For Talent, Office TI Work To Accelerate Despite Cost Burdens
The 2020 commercial real estate slowdown that pushed U.S. office leasing 34% below the 10-year average also dampened construction activity, including tenant improvement projects.
However, pent-up demand in the market is expected to boost TI work during the second half of 2021, according to a report from Cushman & Wakefield that stated high construction materials and labor costs are also expected to continue, though price tags vary across the country.
“We expect that leasing activity will increase in the second half of 2021 as the vaccine rollout continues and occupiers return to their offices in more substantial numbers,” Cushman & Wakefield’s TI Guide report team said in an email. “Activity will be related to new leasing, renewals and the increased demand for space that is flexible and optimizes collaboration.”
Some of the increased demand will come from occupiers needing to make longer-term decisions on lease expirations after putting them on hold last year, leading to what could be a flurry of activity in Q3 and Q4 of this year. Although in the past about 19% of total leasing activity has been in the form of renewals, during the last three quarters of 2020 the proportion of renewals increased to over 31%, according to the report’s authors.
Though construction costs and supply chain issues can fluctuate considerably, both have posed challenges for projects over the past year and there is no end in sight. As of Q4 2020, 71% of contractors reported experiencing building materials shortages. Prices of lumber and copper increased by 37% and 22%, respectively, year-over-year between the end of 2019 and the end of 2020, according to the report, which cited a forecast that copper prices will rise by 11% this year and lumber by 5%.
While some of these added costs may be shouldered by tenants, in high-cost markets that also typically have high rents, landlords could offer concessions to offset TI costs.
“This trend is already setting in,” the report’s authors stated. “Nationally long-term leases (12 years or longer) saw a 6% increase in tenant improvement allowances from 2019 to 2020.”
Despite the high costs and potential delays, JLL Managing Director Bart Lammersen anticipated that most workers will be returning to the office in some sort of hybrid model while only a small subset will continue working remotely, necessitating workspace modifications to accommodate greater flexibility.
“The investment in their employees is still very critical to the health and viability of these companies, and today will be no different than it was going into Covid,” Lammersen said. “If you look critically about where they are from an earnings, returns, stock price, valuations [standpoint], that means the war for talent, the focus on retaining and recruiting is still going to be at the top of their minds.”
With corporate capital spending up by 6.6% year-over-year and venture capital funding also up in 2020, according to the report, there are indications of increased market activity. However, how much it will cost to get offices back up and running again varies by region.
For example, the cost of first-generation build-out starts at $70 per SF in Baltimore and ends at over $200 per SF in New York and San Francisco where costs are highest. Second-generation space costs range from $47 per SF in Baltimore to $165 per SF in San Jose. Generally, U.S. gateway office markets experience the highest costs with average first-generation costs at about $150 per SF and second generation at $112 per SF.