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.
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.
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
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.