“We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten. Don’t let yourself be lulled into inaction.” – Bill Gates
Another day, another article announcing the end of demand for office space. A couple weeks ago, it was a piece in the Wall Street Journal entitled “When It’s Time to Go Back to the Office, Will It Still Be There?” It outlined a reduced number of offices in big city centres and covered the idea that employees will demand more hybrid schedules “that allow workers to stay home part of the week.” This would lead to reduced demand for offices as employees would make use of other spaces, including the home, to carry out their work. Countless other similar articles have appeared over the past month or two, as companies try to understand what a post-Covid-19 world might look like, at least from a workplace perspective:
- “How Your Company Office Could Change in the Post-Coronavirus Era” from CNBC
- “The End of the Office?” from the FT
- “Will Coronavirus Spell the End of the Traditional Office Working Space” from the Telegraph
The list goes on. In this respect, some investors we’ve spoken to over the past month have likened investing in city centre offices to investing in shopping malls and retail warehouse parks in 2014-2016. Back then, buyers thought they saw merely a cyclical adjustment to cap rates but they missed the underlying structural changes to the industry that were happening as increasing e-commerce penetration led to a reduced need for physical retail. Those who failed to understand the structural change happening in the retail space paid the price by investing into value traps that were cheap for a reason. And while the jury still seems to be out on the office market, we would be remiss if we did not even consider the potential that our biggest sector of focus is about to go the way of the regional shopping mall. The truth is, in the aggregate, we do believe it is very possible that overall demand for office space falls – or, at least, it falls for the ways we typically use office space today. The extent to which this occurs depends on whether:
- reducing office square footage and replacing it with remote working saps productivity;
- the cost of office space is so high that companies will choose to meaningfully reduce square footage, even after weighing these savings against expected productivity losses; and
- an alternative form of office space demand takes its place, that is more productive than working from home, yet still allows for material cost savings to firms.
Anyone who has recently spent extended time at home with roommates, in-laws or a crying baby can attest to the fact that while the office may not be perfect, neither is working from home. As a consequence, we believe even a structural fall in aggregate office space demand will not necessarily impact all types of office space and all geographies equally. In fact, we see the arguments for a fall in office demand leading toward higher relative demand for other, newer ways of using office space. Covid-19 appears to have accelerated a trend that was already happening up to early 2020 – the more efficient use of office space provided by flexible office operators. Given these dynamics, we think an office investor who wants to be well-positioned to weather the structural changes that are likely to affect the office markets over the coming decade should hedge her exposure by getting involved in flexible office operations. The irony – and the opportunity – is that the public implosion of many of the well-known flexible office providers, like WeWork, is going to result in a slowdown in the addition to supply of flexible offices due to hesitancy from debt and equity capital, over the same period in which tenants increase their demand for the product.