Office stocks take a hit as omicron variant concerns add to growing slowdown in demand

Stocks of the nation’s largest office REITs moved lower again Tuesday, as the office market faces new concerns over the Omicron variant of Covid. This comes on top of a new cooling in office demand, which had been improving sharply in the first half of this year as Covid19 vaccinations promised a safe return to work.

Stocks of the largest office REITs, like Boston Properties, SL Green, Douglas Emmett and Alexandria Real Estate Equities all fell sharply Friday, when news of the variant spread, and have yet to recover. These stocks had been surging, up around 25% year-to-date.

The S&P 500 also fell on Tuesday, down more than 1.5% in morning trading.

New demand for office space fell in October to the lowest rate since the first quarter of this year, according to a new report from VTS, a commercial real estate asset management company. That is the second straight monthly decline. Since peaking in August of this year, demand is now down 30% nationally.

VTS tracks new tenant office tours, both in-person and virtual, in core U.S. markets as an indicator of upcoming office leasing activity.

New office demand had been surging since bottoming out in June of 2020. It was up 444% by August of this year. Growth in demand was likely due to a more optimistic return-to-workplace scenario, as Covid19 cases fell and vaccinations ramped up. But new concerns are upending the trend.

“As we pass the 18-month mark since the start of the pandemic, employers and employees alike have largely adapted to a new way of working and in many cases, that means permanent remote or semi-remote work,” said Nick Romito, CEO of VTS. “The longer we stay in limbo—the place where, even with vaccines and better Covid-19 treatments, there is still trepidation about returning to work—the greater the likelihood we have a permanent loss of demand for office space and eventually, a new normal. Time is not on the side of office leasing.”

While all major markets saw declines in demand, Los Angeles, San Francisco, Boston and Seattle saw the worst of it. On the flip side, New York, Chicago and Washington, D.C., saw new demand fall by 10 percent or less in October. The differences in these markets is likely due to how strong they were before the pandemic (D.C. and New York were extremely strong), as well as the prevalence of companies with remote-friendly work environments.

Demand is also varying by type of property. That is not captured in the national picture.

“The divergence between top quality office and generic office is accelerating,” said Alexander Goldfarb, senior research analyst at Piper Sandler. “The bulk of the leasing is occurring in brand new construction and buildings that have been heavily renovated recently. The losers are the run-of-the-mill office towers. Covid has accelerated that trend.”

Goldfarb said he is less concerned about the variant than the competition among companies for quality labor.

“The big issue for these companies is the great resignation. Companies are reticent to mandate return to office if they feel their employees can quit and go to another company,” said Goldfarb.

Companies may use the latest variant to push off return to office space, he argues, but office fundamentals are still favorable.

“Our concern on the REIT side is that office is going to be a replay of retail during the Amazon scare a few years ago. The stock performance detaches from fundamentals,” he said.