Offices of the future with real estate executive David Marino of Hughes Marino

OFFICES OF THE FUTURE WITH REAL ESTATE EXECUTIVE DAVID MARINO OF HUGHES MARINO - Video transcript

Joe Kornik: Welcome to the VISION by Protiviti interview. I’m Joe Kornik, Editor-in-Chief of VISION by Protiviti, where we’re looking to the future to examine the big topics that will impact businesses worldwide over the next decade and beyond. Today, we’re focused on the future of work and specifically the future of the office and corporate real estate. We have a great guest to help us do just that. Today, I’m joined by David Marino, executive vice president and cofounder of Hughes Marino, a San Diego corporate real estate advisory firm helping companies develop strategic solutions for their real estate needs — workspaces that work. David, thank you so much for joining me today.

David Marino: Thanks for the invitation.

Kornik: David, I’m excited today to get into the future of the office and corporate real estate as part of our Future of Work initiative. We still have to start with the pandemic, unfortunately. I was hoping that we wouldn’t have to be still talking about this in March 2022, but it looks like we do. I’m curious: How has the pandemic impacted your business, and corporate real estate in general?

Marino: There have been incredible amounts of content produced by industry experts, architects, landlords and brokerage firms about what’s going on, and my lens that I see the market through and this activity through is a personal one. Even though I’m a cofounder of the company, I’m 100% client-facing in what I do. Since the pandemic started two years ago, I’ve spoken to over 800 business owners and CEOs and CFOs. And in my career, I’m out working with clients looking to move their headquarters facilities and their research and distribution facility. In my daily activities, I’m in the market looking at buildings, looking at spaces and firsthand witnessing what’s going on in corporate America.

My perspective is a little different than that of a lot of the pundits, who are maybe looking at some data and some trends, and have an agenda in terms of their presentation. Given that we only represent tenants, there’s really no spin. We’re not advocating for landlords and building owners, and so we’re calling balls and strikes as we see them.

And the reality is, it’s a very mixed story out there. If you’re a biotech company or manufacturing or distribution company, the commercial real estate market has never been better because, even during the pandemic, all of those industries have to be present to conduct their business activities. But if you’re an office tenant, it’s a quite different set of affairs. As everyone knows, everyone that occupies office space in the United States essentially went remote two years ago. The question is, what are they doing now? The reality is, in the market, companies generally have yet to reoccupy their facilities. If you were to walk through most office buildings that were 90% leased pre-COVID, the occupancy levels in those buildings are anywhere from 15% to 25%. Generally, people still have not come back, and what business owners are still struggling with is, will they ever?

Kornik: That’s a good spot for me to ask, “Will they ever?” When you think about corporate offices of that future, workspaces that work, what are some of the big factors to consider when you think about the transformation that offices will undergo in the future? Let’s start with that first question, though: Will they ever come back?

Marino: What I’ve learned is that there are three buckets of employees. It’s different company to company, but employees fall in one of these three categories: There are employees who are desperate for engagement, who only work well when they’re present, who really want to be back in the office at least three days a week, but as much as full-time. Generally, there aren’t a lot of employees who said, “I want to be back five days a week and have a normal workload like I did before including the commute, all the other things involved,” but most people in this category do want to come back at least three days a week.

There’s a second category of folks who want to come back never. There is this work-from-anywhere program where employees have moved away, changed states and left the location where their home office was previously located. So, you have a tremendous amount of people who aren’t even in the same community than they were pre-COVID. Those folks aren’t coming back. Or people who had an hour of commute each day and have simply said, “Look, I’m just never coming back. I’m happy at home. I can see my kids. I have a better relationship with my partner. I’m healthier, I’m happier. I’m saving money not commuting, paying for parking.” So, there’s a whole category of folks that are just never coming back. The reality is, the employer can’t make them. The employer today is effectively powerless in the job market.

Then there’s this third category, what I’ll call the hybrid. Those are the folks who have said, “Yes, I’ll come back for a meeting once a week” or “I’ll come back a couple of times a month, but I don’t really want to be managed. I generally want to work from home or from anywhere, and I’ll see you a couple of times a month.” I’ve talked to companies that are 25 people and 500 people, and everywhere in between, and employees fit cleanly into one of those three boxes. The challenge is, for each business owner, what percentage of your employees fit into each of those boxes?

This is where employers need to move quickly to the acceptance stage of the five stages of grief. The last stage is the fifth, which is acceptance. It is acceptance of the fact that if 30% of your employees say they’re never coming back, well, that’s just true. You can’t wish it to be something different. You can’t say, “Gosh, they’re going to miss out on promotions and culture and communication, and all these other things.” Yes. They’re willing to forgo all that stuff and the beautiful office to live their new life.

Then there’s this other category that want to come in once a week, once a month, that you have to provision some community space for, or co-working space or hoteling space, whatever you want to call it. It is now to the point where employers have to get religion around this. We’re in year two, moving into year three, and it’s not going to be different a year from now.

I’m working with companies real-time that have given up. I, in the last 30 days, have eight different clients that have chosen to sublease their space, that have anywhere from two to six years left on the lease, where they’ve said, “We now have come to acceptance. We have 65,000 square feet of space, and we only need 12,000.” “We have 8,000 square feet of space. We only need 3,000.” “We have 33,000 square feet. We only need 15,000.” I could tell that story thousands of times around the country, and the latent effect on this is huge.

The potential in the market for companies to go through radical downsizing is right in front of our faces, because everyone is now starting to move to acceptance. The CEO and business owners are showing up and seeing that they have five people where they had seats for 50, and they’re not going to continue to pay the rent. They’re not going to continue to carry these liabilities until the terminal point of lease. If they’re silly enough to do so, then they’re going to downsize when that lease expires.

Kornik: What does that mean for the market? Are there opportunities for them to sublease, and what happens to those spaces? What does it do in terms for your business? When you think about strategic planning and design and architecture, functionality, what does that tell you about the future and how it will work? What happens to those spaces, and what does it do to the market ultimately?

Marino: Another question that could have an hourlong answer. I’ll try to keep it brief, though. First, for us as a business, we’re very fortunate that we represent a lot of manufacturing companies and distribution companies and biotech research facilities and office tenants. Certainly, the office sector of what we do is sluggish, but we’re very busy in this other industry sectors taking care of clients, representing tenants and renewing, downsizing, renegotiating, subleasing, relocating. That’s what we do for a living. There is always activity. So, even though a tremendous amount of our clients are office tenants, for us, we’re still going to represent a lot of tenants moving around the market as they downsize.

If you look back at what happened in the prior recessions — let me walk you through. I’ve been doing this for 33 years now. The early-’90s commercial real estate meltdown was a supply-side problem. The market was overbuilt by a lot of speculative real estate and a lot of capital that flooded the market. If you look at the tech rec, you had a demand-side problem. You had the capital markets implode, which caused companies to mostly fail, and therefore default on their leases. Then, if you look at the mortgage crisis of ’07–’08, something similar — again, we had a capital-markets problem that spilled over into the tech and other business sectors that caused a demand-side problem.

It’s different this time. We now have structural change in how corporate America uses office space. The initial shock in 2020 was, everybody vacated their space. But we thought this was going to be over in about six weeks, back in March 2020. So, here we are two years later. What happened are two phenomena in 2020: First, tenants who had leases expiring in 2020 let those leases lapse and didn’t occupy any space. The secondary thing that happened is, tenants immediately started putting space on the market for sublease. In most urban areas, sublease inventory went to record levels: New York City, 22 million square feet of space on the market; Seattle, Denver, 8 million square feet; Boston, 8 million square feet; San Francisco, 10 million square feet — and those numbers have been static since 2020. They haven’t shifted down.

What’s happening is, as tenants that vacated their space in 2020 looked to come back in 2021, a lot of those companies occupied sublease space because they wanted plug-and-play, cheap, low length-of-lease term options. What’s happened simultaneously is, more and more companies every day come to the conclusion that they’re never coming back, so the inventory keeps getting added to each day. It’s stuck in neutral. You’ve got one that comes off and one that comes on. Just as I described earlier, these eight clients of mine in the last 30 days that have dumped space, that is what we’re going to see a lot of this year: Companies that have remaining lease liabilities of two years or more are just going to throw in the towel, because they’re only occupying 20–30% of what they have. I forecast that sublease overhead inventory is going to persist and probably get worse in a lot of markets before it gets better.

But the punch line on all of this is, availability rent rates went crazy in 2020. Some markets, like San Francisco, doubled. Other markets went up 30%, 40%, 50%, and so we saw this incredible spike in 2020. Twenty twenty-one started to flatten off, but we’re going to see over the next three to five years, as more leases expire, that the remaining companies that have yet to address their lease-expiration date are mostly going to get smaller.<>We call that in our industry, Joe, negative net absorption. It’s when a 50,000-square-foot tenant becomes a 20,000-square-foot tenant. That’s negative 30,000 square feet of absorption. We’re in a negative-net-absorption cycle that is going to persist for three to five years, and this is going to end badly for owners of office buildings.

Kornik: I was going to ask you about new construction. I imagine that the construction market is probably thrown into complete upheaval and disruption based on this. Correct me if I’m wrong, but it sounds like you think there’ll be less need for offices in the future. If you were to project and look out five to seven years, would you say that we will have a lot fewer corporate offices, or a lot less square footage, at least, being dedicated to that market?

Marino: I would be so aggressive to say that, with a few exceptions, within the next 10 years, no one will need to build another office building anywhere in the United States. In fact, what you’re going to see is a general repurposing of office buildings. Already, people are having the conversation about “How do we convert these things into multifamily residential?”<>You can look at certain situations and certain markets like San Diego County. In the central-county area, where the biotech industry is so robust, the biotech industry has signed 4.5 million square feet of leases in the last two years, and most of those tenants are going into former office buildings.

In these submarkets, there are 30 office buildings that are being converted into biotech wet-lab research facilities in San Diego right now. Something similar is happening in Boston in the Cambridge area, in Lake Union in Seattle and in South San Francisco. As the life science industry changes, these companies are going into three- to six-story office buildings being converted to biotech research.

You have conversion for different industries happening. To give you some crazy examples, in the South Bay, in Los Angeles County, industrial space is now at a record-low vacancy rate. You can’t find it, because of the supply chain activity coming in through the Port of Long Beach and Los Angeles. So, those companies, to find warehouse space, have to move out to Ontario or Riverside or Corona to get a building.

Developers are going into the South Bay — the Long Beach and Torrance area — and they’re going to be tearing down one- and two-story office buildings to build warehouses. This class B, class C, generic real estate that’s 30, 40 years old, that doesn’t have a lot of value — office buildings with big parking lots — a bunch of those things are going to be coming down in the next three to five years around the port area of Los Angeles, and you’re going to see warehouses pop up. We’re definitely in a cycle where people don’t need these office buildings, and everybody is scratching their heads long-range on what we’re going to do with all this excess inventory.

Kornik: A disruption like this, we haven’t seen in a long time in this market. David, I’m interested in those corporations, those firms, that do plan on keeping a substantial footprint. They’re all trying to figure out what the footprint should look like, how should it be different, how it should function differently than it has in the past — the design, the layout, how many floors they would need versus whether there’d be collaboration spaces or whether there’ll be offices that look like they did a decade ago. What’s your take on that from an architecture and functionality standpoint — of the offices that do remain? As firms move into trying to think about the next five to 10 years, what those offices of the future will look like?

Marino: There are definitely going to be some trends coming out of this. The first trend you’ll see is less of what we call bench seating. It was in vogue pre-COVID: Internet and tech and software companies would have this face-to-face, shoulder-to-shoulder, very small workstation to try to encourage collaboration. Yet, at the same time, everybody was sitting around with headsets on because it was so distracting and so noisy. That’s the funny thing about those work environments: They didn’t actually work that well. They saved a lot of rent because you could pack a lot of people in and they looked cool, but they weren’t particularly humane.

In the post-pandemic reality, with social distancing, employees, to come back, are going to need to feel safe. That means giving them adequate separation among their coworkers, and so we’re going to be looking at a minimum of a six-foot-by-six-foot module going forward for proper safety, or perception of safety and health and welfare. You’re going to see an untangling of the workplace — less of this bench-seating culture and environment.

The other thing you’re going to see is a lot more conference rooms — particularly, small conference rooms. It used to be that people would gather in groups of 8 or 10 or 12, and you had a lot of medium to large conference rooms. What I see in the future is a lot more conference rooms, but smaller: two people, four people — six people, max. That will also help support remote workers that want to come in once a month or once a week, because they can jump into a conference room with a laptop. As people continue to do more video calls and more small meetings and more remote activity, more small conference rooms are going to be the norm, and what I’ll call community space: bigger lunch rooms, bigger social spaces, where someone who comes in once or twice a week with a laptop can sit in a kitchen or lounge area and not need a dedicated workspace or an office. You’re going to see that.

Most companies we’re talking to are trying to figure out the hoteling component. Do they have 10 or 20 workstations in two or three offices that are the remote-working area, where folks can either reserve a desk or come in at their discretion and know that there’s a workspace available for them? A lot of companies are going to be talking about how to accommodate the remote worker, and how to try to get people back to the extent they’re willing to come back — with that point that you can’t make them come back, but you can encourage them.

The last thing, Joe, I’m seeing is companies looking to top-grade. As you’re trying to bring your employees back, if you’re going to bring them back to the same generic office space that’s in an R&D park in a suburban area, that’s nondescript and has no amenities, I don’t know that that’s very exciting for people. The companies I’m working with that are trying to get their employees back, we’re talking about walkability of amenities for food and retail. We’re talking about on-site fitness with lockers and showers. We’re talking about having nicer buildings in a class A location, perhaps closer to mass transit to minimize the commute.

As employers, we’re going to have to bait these people back. We’re going to have to have incentives and inducements and create a work environment that’s exciting and better than they had pre-COVID to encourage them to come back to. That’s what we’re working with our clients on right now — counseling them to spend a little more per square foot, because chances are, you’re going to take less square footage. In other words, moving from a class B building to a class A building might cost 20% more, but if you can shed 40% of your space, you’re still saving money. That’s where I think this is going.

Kornik: David, you’ve given us a lot of amazing information and great insight into the market and the office of the future. We call our program Vision by Protiviti because we like to bring smart people together and have them give us their vision of the future, which you’ve done here a great deal. I want to ask you to look a little further out, and ask if you have any bold predictions. Take me to a decade out or more even, if you could, and what’s possible? What haven’t we mentioned? What haven’t we thought of?

Marino: These trends that I described can potentially even become exacerbated. Look at what’s happening from a technology-backbone standpoint. Entire technologies are being developed today to support remote working, whether they’re online communities — beyond video, beyond Zoom or Riverside and all these tools that big tech like Cisco and these other companies are providing, Webex. There are all of these dashboard management tools for executive teams and business owners to understand what their employees are doing when they’re remote working: Are they logged on? What are they logged on to? How many calls do they have? What are they doing on the internet?

Between management tools, communication tools, community tools, all of the technology that we have yet to even deploy and understand yet, the future is being built on how to support the remote worker — how to make this reality not have to pull people back into the office, So, if you look 10 or 20 years out from now, we have a whole generation of college students in their 20s and young professionals in their 30s who are now being trained to remote work. Those young people, who, 10 and 20 years from now, become the CEOs and CFOs and business owners, they’re going to have been raised with their careers on how to do this well.

I fear it’s here to stay. Most people in my industry who would be on this call want to talk about this being temporary, and everybody is dying to come back, and everybody can’t work from home. That’s wishful thinking, because they want to see these office buildings fill up. That’s in their economic agenda, to see full office buildings. For us, it is what it is. If they’re full or vacant, we just, like I said, call balls and strikes. The reality is, these people aren’t coming back. If anything, 10, 20 years, from now, we’ll see more virtual companies, more hybrid styles of working, that we can’t even imagine today. Unfortunately, the horses are out of the barn, and this trend is here to stay.

Kornik: It sure sounds like it. David, I can’t thank you enough for that look inside the market. Your insights are valuable. You gave us a lot to think about today, so thank you so much for joining us today on the Vision by Protiviti interview.

Marino: Joe, thanks for the opportunity. It’s a real pleasure. Great seeing you.

Kornik: Thanks, David. That was such a wonderful discussion. For VISION by Protiviti, I’m Joe Kornik, and we’ll see you next time.