Reports of the death of the office are greatly exaggerated

Reports of the death of the office are greatly exaggerated

14-10-2020 | Visie
The widespread lockdowns of 2020 have proved that remote working is a valid alternative to traditional office working. This has led many companies to rethink their approach to office space renting, with negative consequences for the market as a whole. But that does not mean the office is about to die, nor that all the investment opportunities are gone.
  • Folmer Pietersma
    Portfolio Manager
  • Frank Onstwedder
    Global Equity director

Speed read

  • Lockdowns triggered a rethink of office renting strategies
  • Offices remains vital for companies to operate and thrive
  • Attractive valuations signal investment opportunities

Remote working is not a new phenomenon. The percentage of employees working remotely varies per country but has been rising steadily over the past decades. Research by Morgan Stanley found that approximately 15% of US employees worked from home one or more days per month prior to the Covid-19 crisis, with 5% working from home more than three days a week. We estimate this percentage could triple to 15% over the next few years.

Offices are important to a firm’s brand and culture, driving employee connectivity, productivity and innovation

Increased remote working will likely have important consequences for office vacancy, though not necessarily disastrous ones. According to research from CBRE, a commercial real estate broker, companies were already transforming their offices into ‘central nervous systems’ before the pandemic, recognizing that offices are important to a firm’s brand and culture, driving employee connectivity, productivity and innovation.

In recent weeks, many prominent CEOs have voiced their concerns regarding the negative consequences of a protracted period of forced remote working, in particular on the integration of new hires. “Not being able to get together in person, particularly internationally, is a pure negative,” Netflix founder and Co-CEO Reed Hastings said in an Interview with the Wall Street Journal in early September1.

Offices are also essential in providing a competitive edge in the battle for talent. Apple and Facebook’s tech campuses are clear examples. The main function of these offices is as a hub. They offer elements telecommunications can only provide to a limited extent: close relationship, teamwork chemistry and culture. Meanwhile, tasks that require limited personal interaction, or none at all, can be performed remotely.

Not as disruptive as ecommerce

These elements argue in favor of a hybrid approach that would combine office and remote working. In fact, a recent survey by CBRE indicated that 50% of employees still want to be in an office environment at least two to three days a week2. So, while the spread of remote working will inevitably have repercussions for office demand, in particular in central business districts, its impact is unlikely to be as disruptive as ecommerce has been on the demand for retail space.

Admittedly, assessing the short and long-term impact of more widespread remote working on the local office market dynamic, and in particular on vacancies, is a difficult exercise. Moreover, the current Covid-19-shaken macroeconomic environment renders any forecast even more complicated. As the crisis lingers, the many foreseeable layoffs and corporate restructurings will likely have a much more significant effect than remote working on underlying office fundamentals.

In an extreme scenario, widespread remote working has the potential not only to affect office markets but also urbanization trends. For instance, since high-income jobs can, in general, be performed remotely more easily and many of these jobs are based in core urban areas, remote working could trigger a migration towards suburban or even rural areas. At the other end of the spectrum, a potential vaccine might also reset this in the coming years, leading to more benign consequences in the end.

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Further polarization + attractive valuations = opportunities

Many factors must therefore be considered in order to assess the impact of rising remote working on office space demand. Overall, a 1% to 2% rise in vacancy per year seems realistic for the coming years. However, such figures are very likely to encompass very different outcomes across local markets. Some segments should prove more resilient than others, as tenants will fare very differently through the crisis. Tech and health care companies, for instance, have so far benefited from the pandemic.

The listed real estate sector, for instance, currently appears to be very attractively valued

Further polarization between prime and non-prime offices is also probable, underscoring the need for a selective approach, focusing on the best assets and the best locations. Such increased polarization might in fact yield investment opportunities, in particular as valuations remain historically low. The listed real estate sector, for instance, currently appears to be very attractively valued, after the brutal correction seen in March.

Although risk appetite returned and listed real estate rose significantly from the trough seen at the end of the first quarter, the sector has kept lagging the broader market over the past few months. The sector also remains attractively valued from a capitalization rate perspective and even more so in relation to corporate bond yields, in light of historical levels. This gap represents a good entry point for selective investors, in our view.

1 Flint, J., 7 September 2020, “Netflix’s Reed Hastings Deems Remote Work ‘a Pure Negative’”, The Wall Street Journal.
2 CBRE, “Workforce sentiment survey”. Survey conducted from 16 June 2020 to 7 August 2020, in 32 companies and 18 countries.