Saturday, May 15, 2021

Post-COVID Office Real Estate Predictions


Here's a list of my post-COVID predictions in regard to office as an asset class. These are just my opinions, I don't have any data supporting them and please consider them to be as valuable as what you're paying for them (nothing):

  • I think this giant work-from-home (WFH) experiment has worked out well. In fact, I think it's worked out much better than many expected, particularly 40-60-year-olds who may not be as tech savvy as their younger workers. And, guess what, the 40-60-year-olds are who are in charge, for the most part. My prediction is this group of 40-60-year-olds have been shocked at how well WFH is going and are going to be much more willing to let employees work from home going forward.
  • With that said, I think employees will still want to go into the office. From all of the studies I've read and the people I've talked to, it sounds like employees want a hybrid approach where they spend 2-3 days in the office per week.
  • From a space planning perspective, employees working 2-3 days in the office as opposed to a full 5 actually doesn't reduce space requirements all that much, if at all.
  • My guess is that demand for office space will be about 5-10% lower than pre-covid levels because of the shift to WFH. My gut says the overall market is anticipating a much bigger drop in demand, implying there could be some overshooting in expectations.
  • This may sound shocking, but with a year or two of inflation and overall economic growth, much of that shock to the demand curve may be fully soaked up.
  • Meanwhile, construction costs have gone way up, implying a lot of planned new construction either won't come out of the ground, or will be delivered at a much higher price point (rent needed) than previously anticipated. Additionally, landlords are converting office space into other uses (medical office and life science, mostly) at a pace that I haven't seen before. The sum total may be a shock to the supply side.
  • These two dynamics (overly bearish expectations of office demand and major shock to the supply side) may make office actually really attractive in the next few years. To me it feels like 3-7 years from now office landlords will have a lot of pricing power.
  • I think fundamentals will be strong for landlords, but I think it'll be bifurcated. I think employers will shift the type of office space they want to highly amenitized, collaborative space. I.e., cool open office space in CBDs where employees can grab a lunch together at a cool restaurant and then hit a happy hour after work. Employers are going to need to entice employees to come into the office and on the 2-3 days that employees are in the office they will want to take advantage of them and really get heavy interaction time with their teammates.
  • Because of this dynamic, I think suburban office will really suffer and the CBDs will experience a majority of the improvement in fundamentals.
  • Suburban office already had industries that were becoming obsolete because of tech (FIRE - financial services, insurance and real estate). Financial planners are going the way of the dodo thanks to ETFs, Betterment, robo-advisors, etc... The 3-man accounting shop that did tax returns is going the way of the dodo thanks to the H&R blocks of the world. The 10-person real estate brokerage team is going away thanks to Zillow. These, historically, are the types of industries that have suburban office footprints. These are also the kinds of groups that can just work remotely and don't really have a huge team of young employees that they need to get together for collaboration.
  • The big question to me is capital flows. I'm very bearish on capital flows coming back to suburban office for the reasons mentioned above. My best guess is that capital flows do come back to CBD office. There's just so much dry powder out there. Right now it seems it's all shifted to industrial, medical and homebuilding from retail, hotels and office. I have to think that some of it will rotate back to office once the fundamentals improve. Right now my thought is that capital will flow back to CBD office as strong as pre-covid, but suburban office will become what suburban strip retail became post-Amazon--nearly uninvestable. It's just a tough prediction to make at the moment because office capital flows are functionally at '0' right now and aren't showing any signs of improving in the near future.

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