Tuesday, August 4, 2020

COVID Impact on Office Real Estate

The big question in commercial real estate markets is what will COVID's lasting impact be on how commercial real estate is utilized going forward? In particular, office real estate is facing an existential crisis of sorts. White collar workers have been working from home since March. Has productivity dropped much? Are teams still able to collaborate effectively? Will people want to go back to the office even after this all settles down?

If the answer is working from home is going to be a big part of the future, then that means office could be facing a permanent drop in demand. If true, then many, if not most, markets would be oversupplied, and landlords could face years of high vacancy and lack of rent growth. The deterioration of fundamentals would lead to less investor demand / capital flows and more unattractive debt which would increase the cost of capital. 


Based on what I've seen and heard, managers are fairly shocked at how productive their teams have been working from home. There seems to have been little productivity loss. Even if there was productivity loss, from a managers perspective, if I have a 10-person team that requires 1,500 SF of office space that costs $50k / year, if I can let half my team work from home and drop the office cost down to $25k / year and my team's still 90% as productive...then that might be a decent trade-off.

Some of the counters to the "there hasn't been productivity loss" arguments are:

  • "There's nothing to do right now. People can't travel, go to bars, etc... When that starts up again, there will be a big productivity loss."
  • "People have been predicting the demise of the office for years. It hasn't happened yet. Why would it be different this time?"
I think both arguments have merit. The first certainly has some truth, but at the same time, anyone with an internet connection and a computer has access to a lot of entertainment options that didn't exist 10 years ago (Amazon Prime, Netflix, computer games, social media, etc...). The second is also true but I think there is an argument that things are different this time. For example, take a look at this chart showing internet speeds from 2007-2017 (couldn't find anything that went to 2020...):

From 2007 to 2017, the average internet speed in US households increased 10x. I'm sure now in 2020 the average is well over 20 mbps. Just think of how much better working remotely would be with 2020 internet speeds vs 2007. Similarly, we just have better tools to enable working remotely than we did in the past. Dropbox has made VPNs somewhat obsolete for many businesses. We have programs like Zoom and Teams, combined with improved household internet speeds, that enable 20+ person video meetings. There are many more examples...


From my work-from-home experience, I've found collaboration to be more challenging. Anecdotally I've heard the same thing from other managers. It just is easier to walk into someones office / cube and ask them a question vs calling or emailing. Communication is also just easier, in my experience, in-person vs over the phone / video call. People are more likely to interject and contribute to a 5-person meeting that's happening in-person vs over a video call.

To me, the bigger problem is that you lose the relationship building / human element of the work experience. I think it's important to get reminders that your boss / people you manage / colleagues are human beings and not just work robots. I don't think you get those kind of reminders unless you're in the office, going to lunch together, doing team building events, etc... One of the perks of working for a company is you get to meet people, build a work relationship and expand your network. I just don't think that growth is happening without going into the office.

A compelling counter to the above argument is "well, it sort of levels the playing field on company culture. A company with a crappy culture that made going into the office unpleasant now isn't that different than a company that had a great office culture. It's actually giving employees more / better work options. Likewise, should people really be getting jobs / ahead in their careers because of networking? Doesn't that just encourage frat-guys to keep hiring each other?" As I said, I think this argument actually does have some merit, but I think the positive aspects of office collaboration still outweigh these downsides.

Do People Want to Go Back to the Office?

Anecdotally, here's what I've heard:
  • People with living situations non-conducive to working from home (live in a small apartment in a big urban city with lots of street noise with 2 young kids, for example) can't wait to go back to the office
  • People with really bad commutes like working from home and want it to continue
  • People with very isolated job roles that don't require collaboration like working from home
There are obviously many other situations and an infinite number of combinations that aren't as black and white. There's also the whole COVID issue and whether or not people will have a major mindset change regarding their willingness to be in crowds. Will people just be more skeptical / unwilling to be in a crowded office even after the COVID pandemic is over? Will people want to jump on a crowded train to go to the urban core and go stand in a crowded elevator to get to the 10th floor of their office where they share a bathroom with a hundred other people? My gut says things will more or less go back to the way they were on this front, but who knows...

Conclusion / My Thoughts

Given the above discussion, here are my thoughts on how things will shake out:
  • Working from home is a better / more accessible experience than it was
  • Employers are much less skeptical of working from home than they were in the past
  • Employers are more likely to let employees work from home going forward
  • Some people will decide to make working from home a more permanent thing post-COVID
  • This goes back to my post on forecasting future events--when predicting tomorrow's weather, the most accurate prediction is that it will be the same as the previous day--applying that principle to office in the post-COVID world, things will likely revert back to how they were--people will be okay using public transportation and crowded elevators and there won't be a major behavioral shift
  • Taking the above into consideration, there will likely be a long term shift of the demand curve for office
  • I don't think it will be a major shift that will destroy the asset class, like what happened with online shopping and big box retail, but there will a demand hit and the asset class will under perform vs historically for the next handful of years--this will create opportunity for smart allocators

No comments:

Post a Comment