Thursday, September 24, 2020

C&W Office Forecast

C&W came out with an interesting study on the office asset class. Here's the link: https://www.cushmanwakefield.com/en/Insights/COVID-19/global-office-impact-study-and-recovery-timing-report

A few takeaways:

  1. In general, for a brokerage house to publish something with a relatively bearish slant like this is interesting. I say it's a bearish slant just because I think most other shops are saying the recovery will be a bit quicker than this C&W report.
  2. They're forecasting a brutal 2021. Overall, they believe the negative impact on office fundamentals from COVID will be greater than from the great financial crisis.
  3. Post-COVID, C&W is forecasting the share of professionals working from home to double compared to pre-COVID.
  4. C&W thinks it's unlikely that average square foot / employee will increase. If anything, they think it will continue to shrink or hold steady. This is important because some office investors think employees will demand more space in their offices, creating more demand, and potentially offsetting reduced demand due to work from home. C&W doesn't see that being the case.
  5. C&W is forecasting occupancy and rents to not fully recover until 2025.
Investors will read this and then wonder, "When is the correct time to jump in the market?" It's an interesting question. An investor might think, "Gee, I'll just wait until the fundamentals start to improve in the second half of 2022 or early 2023 when prices have hopefully hit bottom and I should make a bunch of money..." This hypothetical investor might be right, but there are a few other factors to consider:
  • Markets are very efficient at pricing in future events. If you wait until the fundamentals turn positive, you might be too late.
  • It's possible prices don't necessarily track fundamentals. For example, in the Bay Area some submarket fundamentals didn't get back to dot-com-bubble highs of 2000 and 2001 until the mid-2010's. Does that mean prices were at their peak in 2000 and 2001 and didn't get back there until the mid-2010's? Nope. Actually, prices were back to their dot-com-bubble highs between 2004-2005. How is that possible? Well, interest rates dropped like crazy. This pushed cap rates down and offset the decline in fundamentals to the point where it actually pushed prices back to dot-com-bubble highs. This means buying opportunities may not be dictated by changes in fundamentals. 

  • Using the great financial crisis as a data point, commercial real estate lagged the overall recovery by a few years. The trough in the overall economy was in 2010 and it wasn't until 2012 that commercial real estate hit its low. The big differences, in my opinion, between then and now is that commercial real estate was overbuilt and there was an issue on the supply side along with the issue on the demand side, and leverage was much more extreme. This cycle, it doesn't seem like there's as much of a supply issue and leverage has overall stayed much more conservative. There is also a lot of dry powder on the sidelines that can come in and recapitalize deals if needed. For those reasons, I think there's a compelling case to be made that prices will not drop dramatically.
It'll be interesting to see how correct this C&W paper turns out to be. It tends to go along with what I think the future of office looks like, but we'll see.

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