Real estate and Covid-19: 'The office is not dead yet'.
By Alex Rolandi
As the prospect of a second wave of coronavirus still looms, many parts of the world are slowly reopening and people are returning to their workplaces, ever-changing social distancing measures in place. For many office-based businesses, this poses a challenge – it’s not always easy to maintain your personal space in a lift heading up to the tenth floor.
But in the midst of an accelerated trend towards more flexible working, offices are not dying out just yet. It’s the way companies will use them that is likely to change, according to Paul Kennedy, head of strategy and portfolio manager for real estate in Europe at JP Morgan Asset Management (JPMAM).
The future of city office lets is a major topic, he tells Funds Europe. This is not a new trend, he says.
“There’s been a trend towards flexible working, towards more technology-based solutions for many years now. If we look back, if this crisis had happened five or ten years ago, the technology wouldn’t have stood up as much. I think the conclusion we’ve reached as a business is that we can all work from home – but we don’t want to.”
Office rents can be pricey, though. Regardless of how governments lift lockdowns, companies will rethink how they manage their office space in terms of functionality and safety – and in terms of saving on capital costs.
Indeed, the commercial world is in new territory, according to Gunnar Herm, head of research strategy for Europe at UBS-AM Real Estate & Private Markets (REPM).
“There’s a lot of opinions and guessing, to be very honest,” he says. “A lot depends on how businesses will react post-Covid. It is unlikely that businesses will move to a full home office environment, but working remotely will become more standard.”
The office sector remains a dominant force in the real estate market, however. In Germany, for example, it accounts for around 54% of open-ended property funds on average, according to research by Hamburg-based Intreal.
These open-ended funds have remained resilient throughout the pandemic, seeing inflows of €1.3 billion throughout March, April and May. At the height of the crisis in April, open-ended real estate funds’ net assets still surpassed €110 billion, Intreal’s report shows.
Many companies have had to furlough people to keep going. And many have done well to survive due in part to technology, as they continue to pay staff who work from home as well as the rent on their office space.
Virtual working has proven robust enough, and many employees may have found a respite from the rat race and daily commute a blessing – but life through a screen is never the same.
“I’ve just had an investor meeting with people primarily from Asia,” says JPMAM’s Kennedy. “This time of year, we’re meant to be with them face-to-face for our annual meeting – but we can have a conversation. It’s not the same, but it’s proving far more effective than we thought it was going to. The quality of the technology has been amazing.”
For Stuart Pinnington, group funds and institutional director at fund administrator IQ-EQ, it is still too early to say what trends may form coming out of this crisis – but there will be differences between cities and countries. What is clear, he says, is that Covid-19 has changed people’s perspectives on working practices.
“Many of those who had not worked at home before have relished the opportunity to do so. The situation has also caused many employers to reconsider their views on the productivity of employees working from home. But does this mean the end of city-centre offices? Definitely not.
“Many employees living in cities are keen to return to the office, albeit perhaps in a reduced capacity with a more flexible home/office split approach,” he says.
Bearing in mind the many mental health and relationship-building benefits that working in an office environment brings, he argues, there will always be a need for city offices, especially as lockdown subsides and in-person meetings resume.
However, in Pinnington’s view, a review of space requirements is inevitable, possibly entailing smaller floor plates, flexible working environments and even flexible lease terms.
The types of spaces that companies are going to require will become more diverse, and they’re going to require more space per person, according to Kennedy. Developers will also have to keep up with changing occupier demand.
“You’ve got these offsetting trends happening, where fewer people are going to be in the office at any one point in time. Space requirements per person are going to go up, but overall space requirements will go down. You’re also going to see a change in the type of space that the occupiers are going to require,” Kennedy explains.
“It will be particularly bad for high-rise buildings on the social distancing side of things, so I think there’s an obsoletion issue there as well as an aggregate demand issue.”
UBS’s Herm suggests offices need to provide added value, as well as a reason to go there in the first place. “Is it really necessary that [employees] commute to the office in the future? Does the office really provide and add value for executing accounting, for example? A lot of those functions of work would be rationalised by digitalisation anyway, and that’s also likely to accelerate due to the pandemic.”
Despite this, Herm says the outlook for city-centre office space, from an investment point of view, is still relatively positive, even though fewer people are working in offices at present. (“Everyone wants to avoid public transport as they see it as a source of risk.”)
But public transport is likely to continue to play a major role in the future of urban spaces, especially when it comes to ESG investing.
“City-centre locations offer value-add,” says Herm. “They are likely to be required by the office tenants in the future.”
As with many things in life, interconnecting factors are at play. According to Kennedy, it’s a tremendously interesting time for the residential sector as well. With more people working from home, they are going to need more residential space.
Workers paying dearly to be closer to their offices may reconsider if they only need to be at their desks a few times a week. Working less in the office may make a longer commute that bit more attractive, according to Kennedy.
“It means that you’re going to see potentially a reduction in demand for higher-value locations. We’ve already seen a reduction in rents in San Francisco, for example, which has always been both high value and high volatility.
“But you have companies like Facebook and Google who’ve said they’re moving away from having an office-bound workforce. If normal companies are going to go to two or three days a week in the office, they may even go to having a workforce that’s not anchored to any particular office.”
Google and Facebook may have changed the entire real estate landscape of San Francisco. Kennedy has heard of tech workers compromising on quality of life to work for the likes of Facebook: they would commute two hours to the office, albeit in WiFi-enabled buses provided by their employers.
As former Google chief Eric Schmidt has suggested, companies may loosen their ties to offices and go for a hub-and-spokes type of model. Rather than mixing working from home and going to an office, he says, employees could mix working from home with working from a range of offices.
This type of working model, of course, applies only to those with the freedom to take their workstation wherever they go. Kennedy points out that this is not a Covid issue, but a trend towards greater flexibility. “It’s the fact that people like us can put a laptop in a rucksack or briefcase and go from one office to another. You’ve got all your data in the cloud and you’re not tied to a filing cabinet like you would’ve been 20 years ago,” he adds.
“This is a natural struggle of this trend towards greater flexibility, it’s just been accelerated, and it’s just been given a massive stress test by Covid-19. People are going to require and are going to be offered greater flexibility in how we work and where they work.”
According to Axel Drwenski, head of research at asset manager KGAL, the concept of what constitutes a good location has been changing in recent years. He believes the pandemic has accelerated this trend. “This applies not just to the inner-city prime locations, but also to satellite locations which benefit from good public transport system access and sufficient amenities of daily needs as well,” he says.
Those who can work from home will likely do so for the foreseeable future to free up office space and save money, as well as avoid the risk of infection. This means investors will have to pay more attention to the functionality of the buildings they invest in – in terms of, for instance, how robust they are to crises such as the pandemic and how good the ESG credentials are to offset other future risks.
According to UBS’s Herm, some investors started to change their approach to real estate a few years ago – but the majority still think in terms of providing space that tenants should occupy. “Now I think things will move more towards the direction that you, as a landlord, should understand the reasons why this particular tenant wants to use that space,” he explains.
Investors have to understand the operational needs of a business seeking to operate in any given area – “and that means you become much more operational as a real estate investor”.
Maybe it’s best not to rush to conclusions about the future of office work. The death of the office has been a regular theme for a while and shows no signs of dying out yet. It’s just going to change. As Kennedy says, investors have to ensure their investments are resilient to that change.