I'm long office properties
I realize this POV maybe to the current state of the workplace, but I'm long office for a number of reasons (none based on mathematics).
Social creatures: we humans are social creatures. a world in which we all work from home isn't gonna happen.
Culture: jobs pride themselves on building a culture. Can't really do that with WFH.
Promotion: for those who want to advance up the corporate ladder, studies have shown it's harder to build relationships via remote. Simply put, the ppl who are working at the office are the ones who will get the promotions.
Thoughts?
Was hoping that someone else would pipe in first (since I am highly biased here) but I agree. All of the qualitative reasons you mentioned above (and many more) are certainly true and indicate that we won't be working alone in our spare bedrooms forever.
As far as the math - a couple of variables that have been debated a lot over the past 9 months make it tough to pin down: what % of people will come back to the office? and how much space will need to be leased per individual?
The other piece that will be interesting is where the office comes back. If you look at high-demand cities prior to covid, vacancy had been essentially nil which drove up rents across the full spectrum of space (rising tide lifts all boats). As companies come back to an environment with additional vacancy, I think there is going to be a bifurcation of results/returns between high-quality, modern office space and traditional/commodity space. Flight to quality is going to buoy demand for top-quality buildings and those landlords will benefit while performance in older and lower-quality assets will lag. This is exacerbated by the high capex costs associated with aging office buildings and is going to further the performance gulf. Somewhat related, but the geographic trends are going to be interesting to follow here too. The gateway markets are not dead, but their varying degrees of hostility towards businesses (and seemingly societal norms) is causing some exodus on the margins. Top assets in these markets are going to remain in demand from the companies that don't leave, but if I owned the worst building in a New York, SF, LA, Boston, etc. market today - I'd be a little concerned.
As far as how to make money on this thesis? Long answer: Still not seeing huge discounts in the private markets - conservative financing, and relatively few defaults amongst tenants is creating a deceptively sanguine environment for owners - not anticipating blood-in-the-streets distress like GFC or S&L. Public markets offered some discounts in March (some of which still exist to varying degrees) which can be appealing, but this can create a bit of a issue with REITs who need to constantly raise money to operate their businesses so beware of value traps or impending dilution... Short answer: Idk where opportunity is but let me know if you see it.
Awesome post.
Intern here. Could you explain the value trap / impending dilution that you mentioned in your last paragraph?
I think that there are going to be some persistent impacts from the crisis - so if you are valuing a REIT based on trailing cash flow or 2019 "normalized" NOI, you might run into trouble. A "value trap" would be a company that looks cheap based on the historic numbers (results, ratios, etc) but what appeared to be a cyclical challenge turns out to be permanent and valuation doesn't recover. REITs need to distribute much of their cash flow, so they need to raise capital (issue debt, sell equity or sell assets) to survive. If they need to issue equity or sell assets at unfavorable valuations due to impending debt maturities (or just to fund operations during pullback) shareholders are likely to get diluted.
What was pretty appealing last year was that many of the blue chip names who traded off 50% or more had spent the last decade after the GFC shoring up their balance sheets. With no debts coming due in the short term, companies have time to circle the wagons or just wait for the market to improve.
I've been totally behind these points you've mentioned... like those themes will play out. But I'm not necessarily "long" office. There's a universe where big brand new trophy office will have a market, and if you build it, they will come. But for the rest of the space, there will inevitably 99.999% be a painful right-sizing. Some industries and spaces, like commercial real estate as an easy example, will flock back to offices (some of my peers i've heard are already rotating in and out). Personally, I'm dying to get back to a pre-covid happy hour and get free drinks from brokers. Generally, I have no clue how I would progress in my career long-term by not interacting with people in person (I'm on an acquisitions team)
Other industries, commodity jobs (lets say, certain % of call center jobs) are jobs that if its possible to train, scale up, and monitor that workforce if they're working from their kitchen tables, and its a preference for the worker, i think it's game over for those tenants.
The challenge going forward is discerning between which office real estate is attractive at the right price and which office is truly obsolete or heading toward obsolescence. It'd be ridiculous to just "write off" office as an investment category entirely. That being said, pre-covid Class B office was already a minefield of value traps. Post-covid... idk man. Next two years are going to be rough. Hopefully I'm wrong, seeing as half of the investments I evaluate are office.
I was working for an office owner operator who focused on value-add with only a few core properties to keep the lights on (got laid off in August 2020) and can confirm your value-trap comment. Acquisition assumptions had to be juiced to get deals through IC and of course the metrics were never hit. Deals we underwrote at 15%-20% IRRs we’re ending up at 8%-12%. Even prior to the pandemic, all our capital improvements ended up more expensive than budgeted, leasing velocity was slower than anticipated, rent growth assumptions fell short, and TIs always came in higher than expected. It was rare to get a win. I was with a GP, and on the AM side I was staffed to 10 properties across 4 JV funds and only 1 fund (three properties) was forecasted to be in the promote.
Intern here. How common is it for funds at your firm to not hit promote?
I don't think anything you mentioned here is too contrarian. I agree with the first two points, but I tend to disagree with the last one regarding promotion. Promotion is something that I think will greatly depend on the firm culture. A lot of large multi-national corporations already started to do hybrid schedule runs pre-covid; as a result, have yielded positive results in overall employee well-being. And with that being said, I think this is something that will greatly shift in employee expectations and seep into the broader & future workforce. Also, as a lot of employers have come to realize--if they haven't already--their workforce is completely capable of working remotely while still maintaining production. I think the shift when all this nonsense is over will be opting for a more hybrid schedule (I.e. 3 days in, 2 days out).
As far as future expectations for office supply & demand goes, I subscribe to the camp that in addition to those fleeing the urban residential market that we will see a similar trend in the urban office. Once this all ends and more and more F500 corporations are "calling" employees back in, do you really think everyone is going to get pumped about a 2 hr commute(both ways) when they were used to rolling out of bed, showering, getting dressed and being connected all within 5-10 minutes and saving themselves the ~2 hr commute each and every day for the past year? With that being said, I think there will be an uptick in demand for a suburban office present--especially in town center venues.
Mostly agree, but my thesis is much simpler. In WW2, the Germans bombed the living hell out of London. Something like 30% of all structures were destroyed, and some estimates are that up to 50% of all structures were rendered uninhabitable by the bombing campaign. Yeah, it took the Marshall Plan, but by 1960, London was more or less back. If a Tier 1 global city can survive being literally bombed to shit, I don't see how NY doesn't come back once vaccines are fully distributed and Covid-19 becomes a seasonal concern for which we get an annual shot like the flu.
Because that was a completely different time under different circumstances. Businesses in London could not simply say "well, we were bombed to shit, so every WFH" the way businesses can now. The loss of an office space back then was devastating, but it no longer is like that.
I understand your point, and I'm well aware of how WFH changes things. In fact, I was once upon a time in corporate real estate and spent my days trying to set up the legal office of the future, where lots of people would work from home, and we'd hot desk, and even partner offices would be 175 sq ft max. You'd be surprised how little traction any of this shit got, and that was like 5 years ago max.
That being said, business is almost always more functional in person. Its just the way that opportunity and humanity works. The guy who can look you in the face, shake your hand after the pitch, and take you to drinks after is going to beat out the guy who zoom pitched you. There are lots of Bloomberg articles about guys leaving NYC for Florida, and sure, at the margin, it'll be a thing. But lets face facts, most of these guys aren't 'actually' leaving NYC. They're just trying to cheat on their taxes a little and establishing residency in another state. Maybe they'll spend a little more time in Florida than they would otherwise. They're still going to spend much if not most of their time in the city, and its just not going to change.
This goes triple for anyone who isn't a wealthy senior business executive. If you're a 22 year old kid seeking a job in finance/tech/biglaw/insert profitable career here, there are about 3 dozen reasons why you're better served in NY, SF, LA, etc then Palm Beach or Houston.
I guess my point is that functionally, while technically feasible, it still isn't really possible for companies to just say OK, everyone work from home from now until the end of time.
I'm long $OPI in my PA
+1 SB "Don't tell me what you think - show me what's in your portfolio"
As the other posters here have mentioned I think it depends by product type, geography, and even sub market. The commodity B suburban office building is dead unequivocally. Call center and back office jobs are absolutely going remote. Urban and infill office especially new trophy product will do well across the sun belt and even nyc. I think sf/la may be big fucked long term so I’m hesitant to talk about those cbds in absolute terms.
I'm really interested to see how the class b/c infill buildings play out in the next few years. I don't think anyone doubt that the trophy offices will be strong (will they hit their original uw is a diff question), but with many non FO jobs going remote or being relocated out of expensive urban centers, there should be plenty of dated stock in serious trouble.
Couldn't agree more on the non-FO jobs.
Every time I see REPE folks stark to talk about the future of office real estate they project their own personal circle and the culture of their own company on the overall economy (a bias we all have).
Of course when you talk other PE guys, or your law friends at Clifford Chance or your consultant buddy at BCG - they're are all going to have their own office desk going forward and I agree that these roles are more fruitful when everybody is in the office.
But how about the cyber security guy from KPMG? Or the presentations guy at Goldman? I don't want to sound elitist - but these back office jobs will increasingly pivot towards WFH in the long term - there is no need for these people to commute >60 minutes per day.
Even though this makes me a bit worried with regards to office real estate it needs to be said that these kind of jobs have already started to transition towards WFH before the pandemic.
Couldn’t agree more
so is Sam Zell, so is Bruce Flatt
POV from an NYC tenant rep: There's been a seismic shift in the necessity for office space from groups that inflated the market from the getgo- tech, startups, finance, media etc...
Capable and forward-thinking LL's realize this and are doing deals up to 50% off pre-covid. Generational LL's of Class B/C accept the lower taking rent while the big swinging dicks give 10 mo. free on a 5-year lease to satisfy lenders- both end up with the same effective. Every building is a market in itself, some are worse off than others, but the common theme is that they are all worth 20-50% less than a year ago.
I firmly believe that remote work is overblown and that the office is here to stay, but the fact of the matter is that an office is valued A LOT less by a company than it was a year ago. The heady days of irrational exuberance and excessive spending on office space is a thing of the past. The value of a space is now the opinion of the prospective tenant, not the landlord.
Doom and gloom aside, all this is good for what was a truly overheated market. Seeing a lot of movement from small/medium groups looking to take advantage and there's a common theme: the office is only worth the value it provides to a company. This was not the case before.
TLDR
Bullish: No
Optimistic: Yes
Speaking to office agents recently I heard a few interesting points. A large commercial RE firm in London (CBRE/JLL/Cushman/Colliers etc) are supposedly looking for 3 to 4 desks per 10 people in their next office which would be a huge change. It’s based on the premise that people will WFH a few days a week so much less requirement for space.
I think the sustainability of offices will also be huge and end up rendering Grade A space obsolete much faster if the offices do not fit corporate occupiers CSR policies.
From a developer’s point of view, we are still looking at office opportunities but unlikely to build speculatively as we would have a few years ago. We’ll look to pre-let at least 50% before putting a spade in the ground.
What kind of office buildings are you more likely to build going forward, from a developer's perspective?
I'm short office.
-Shorter lease terms becoming more common but concessions staying high
-Big chunk of leasing demand is now permanently gone
This being a career focused site, of course we care about face time, promotions etc.. but the vast majority of society does not. There are so many inequality stats out there that huge chunks of millenials are just giving up on becoming wealthy. They'd rather have more free time given that buying a Ferrari is out of the question in today's economy. CEOs would prefer to pocket the money they would've spent on rent, only the mega cap companies really care about their brand/culture.
Man Idk. Alot of ppl are dying to get back inside an office.
This may be true for people in your professional network, but if sampled your Facebook friends list or stopped people on the street, you would find most people love work from home and would even go so far as to switch jobs to maintain that arrangement.
I hope you are right. Generally I’d agree that humans are social creatures, but I doubt that translates into people desiring to go to the office. There are very few people who genuinely enjoy that aspect and prefer maximizing social relationships outside of work. Thoughts?
Like you think ppl are gonna forever work from home and then log off and do nothing? I've had a Zoom happy hour, that shit sucks.
Did you just project the fact that you have no life onto everyone else lmao
I think the headcount demand in offices will shrink, no longer 100% of staff in the office 5x / week.. but the space required by each head will gradually rise. The cubicle is on its way out, offices will feature more open layouts with communal work and recreational space. A lot of the newer class A in Sf/Sunnyvale/SJ is starting to build off this model.. Will take a significant amount of time for this to all play out.. short term.. think things will be bumpy.. don't like suburban office.. over the long team though, more bullish than bearish
The people making the decisions to go back to the office are the people at the top with corner offices. Those people are pandered to every day in an office setting. When they work from home, they don't get that. Since the pandemic started, they don't have every single person smile at them and pick up their pen when they drop it. Their dopamine rush has fallen off of a cliff. Their bodies are screaming for it to come back.
Junior employees that want to move up quickly will want to be visible and top of mind, which means they will also want to come back to the office. Mid-level employees will be worried about the eager 20-something taking their position, so they will want to come back.
Unless there is real structure and a schedule put in place top down, everyone is going to be fighting for the floating desks.
WFH ppl are gonna watch ppl in the office getting the cool assignments and crushing deals and rapidly advancing.
Then they will be in the office too.
Short-term Bearish.
Long-term Optimisitc.
Speaking from someone who works for a firm that primarily invests in office space on the West Coast, we are seeing leasing ratchet up significantly, but are still seeing pretty aggressive offers on discount, and shorter term deals. If this is already happening with the West Coast not opening fully for a while, I'm not surprised you are optimistic.
I'd generally agree with the comments about the long-term value of office space, but it's tough for me to be bullish given current price levels. In fact I'd say the investable universe for office space probably offers one of the worst price/value tradeoffs in the post-COVID world.
Obviously offices will not go away entirely, but the important question is the extent to which demand will be reduced. Availability in every major metro is currently the highest it's ever been (vacancy still lagging a bit due to in-place leases). Say 25% of office space is rendered unnecessary in a "steady state" now that firms know they can operate remotely: this would have a massive impact on investment returns in the asset class for several years. Class A building owners will be able to lower rents to pull tenants from class B/C space, but I think older buildings will be struggling with huge blocks of vacancy far into the future.
Meanwhile on the pricing front: Implied cap rates in the public markets, say SLG and VNO, are essentially back to pre-COVID – their stock prices are still 25-35% off pre-COVID due to lower earnings estimates. In the private markets, there's been almost no transaction volume except for buildings with long-term leases to credit tenants – so "ask" cap rates have not moved at all. Meanwhile the real estate debt markets are as flush with liquidity as they've likely ever been, allowing building owners to refinance at valuations that in retrospect will likely look inflated and based on pre-COVID market assumptions. Lenders are great at underwriting in-place cash flow, but not so great at getting it right far into the future – just look at the malls loans going to zero in CMBS right now.
Overall, although I share your optimism for office space long-term, I think we're still in the opening innings of how COVID will impact the office market (and in a market that is heavily distorted due to government intervention). There's a real possiblity that office investors are in for years of pain in the 2020's.
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