Excellent white paper by my friend Christopher Rising on the future of office portends that the office is not dead, but changing with the novel coronavirus being a hyper accelerator of that change. We agree with Chis that the primary value of the workplace is to enable workers to gather, collaborate, innovate and perpetuate their business. The Covid-19 pandemic is layering onto these elements what Harvard and other researches have long been saying, “health, wellness and lifestyle” are critical components to enabling these pursuits to flourish.
People who are pursuing careers and seeking recognition and job growth or need to be collaborative will continue to seek out the office environment. Will they seek it every day, no. Will they abandon it, no. They will opt for efficiency and effectiveness, safety, wellness and lifestyle. Worker utilization is likely to drop 15-20% as work from home (“WFH”) becomes optional and acceptable. Social distancing will roll back the clock on densification necessitating additional “me” space for workers. The short term net effect is likely to be in favor of WFH, mostly because it is easily adaptable. De-densification, is a lot more complicated in that it involves substantial remodeling of office space.
This temporary reduction in office space demand drive office vacancy to exceed 20%. Rents are likely to drop 10%-15% as the office sector becomes a tenant’s market. As noted in the Rising paper, it could take 3-5 years before returning to 2020 Q1 levels. Values for any assets with rental risk will drop correspondingly 10-20% as it will be very difficult to ascertain income levels. Low interest rates will buoy capitalization rates, but they remain resilient to further downward pressure due to low yield alternatives. Net operating income (“NOI”) can be expected to fall by 5%-20% from both declining rental rates and the need to increase operating and capital costs to make offices safe and healthy. Refinancing will be very challenging for many owners due to pressure on net operating income.
The pressure point will come at the ownership level in the next 6-12 months as owners will need to invest significantly in new operating protocols and capital improvements to create these healthy and productive environments workers will demand. The legal implications of failing to do so have yet to be tested. Tenants may seek creative legal solutions to reducing their real estate footprint and workers may seek legal redress if they feel that an office environment is unsafe.
People will return to offices, but the costs of implementing new operational protocols and modernizing many office buildings, most of which are well over 40 years old, with healthy work stations, safer offices, better HVAC systems, touchless access, air quality monitoring, and outdoor spaces, to name a few, will be significant. The Covid-19 pandemic is not the death of office, but rather a great accelerator pushing owners and investors into a new age of “Perfecting Property Performance” for the office worker. Investors in office will have to create better curated workplace and lifestyle experiences for workers that not only enhance the office work environment but seamlessly integrate it with the mobile office and WFH preferences that promote a more productive, healthier and purposeful lifestyle.
Yes, office will survive and thrive. It has been resilient for centuries. It will just be different.
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