In this AFIRE Summit piece, we explain the drivers that will affect the demand for office in the recovery ahead.
The US office market has been in a state of suspended animation since COVID-19 sent most office workers home more than a year ago. As one indicator of this, utilization rates for office buildings in Barings’ portfolio and across most major US cities, as of June 2021, have started to creep higher from the sub-20% levels where they have been for most of the past year, but limited office leasing and sale transaction activity has deprived the market of meaningful price discovery for assessing the pandemic’s impact on rents and prices.
Unsurprisingly, while few doubt the office sector faces a difficult near-term road ahead, there is far less consensus among real estate lenders and investors about future demand for office than any other property type.
Broader adoption of remote work will likely be a net negative for office demand going forward, but the uncertainty and differentiated landscape will create opportunity for discerning investors. The forced work-from-home (WFH) experiment during the pandemic has effectively compressed years of obsolescence into a span of about eighteen months, and both companies and workers will increasingly have the ability to substitute technology for physical office settings. However, the top strategic priorities for most companies post-pandemic will not be terribly different from those before the pandemic—namely, growing earnings and attracting and retaining the best talent. So, while earnings objectives increase the likelihood that companies will find a way to leverage technology to reduce their real estate costs, the intensifying war for talent will continue to make the office important—perhaps even more important—as a place for collaboration, cultivating corporate culture, training, mentoring, socialization, and productivity.
For investors with or seeking office exposure, three drivers—(1) the transition to a hybrid workplace, (2) employment growth in science, technology, engineering, and mathematics (STEM), and creative industries, (3) and the escalating war for talent—will shape office demand in the recovery ahead and ultimately determine which assets and markets will be winners and which will be losers.