January 10, 2022

Where There’s Disruption, You’ll Find Opportunity

By G. Evan Bennett
Collaborating millennials working in an office

There’s no sugarcoating the truth. Investing in office properties isn’t as easy as it used to be. For better or worse, the COVID-19 pandemic has ushered in profound changes to how office properties will be designed and operated in the years to come. In turn, these changes are going to have an impact on investment performance in the sector. Or, as my friends at all the startups like to say, these changes will disrupt the sector. Will that disruption uncover any opportunities? I’ll give you one guess.

Been There, Done That

Although investors were hoping for increased clarity going into 2021, the future of office continued to remain uncertain throughout the year. Ironically, one of the primary reasons for this uncertainty was the seemingly logic-bending resilience of the office sector to the effects of both the pandemic and the corresponding recession. Everyone, especially opportunistic buyers, were on the lookout for a wave of distress sales that never materialized. Fundamentals have held up surprisingly well. Although vacancies have generally risen across the board, relatively few tenants remaining in place have stopped making rent payments – at least in the markets I follow. And this is despite many of their employees continuing to work remotely.

An explanation for this is how the office sector has benefited historically from long-term leases, typically with durations between three and 10 years, depending on building class and creditworthiness of the tenant. When leases roll this infrequently, any immediate impact on asking rents and market values brought on by changes in the general economy will be muted, at least relative to some other property types. Specifically, during the early days of the pandemic, many tenants on the lower end of the creditworthiness scale were able to continue paying rent due to government payouts and other support programs, such as the Paycheck Protection Program. While tenants at the upper end of the scale, not knowing exactly what the future holds, didn’t want to risk losing their space if they’re only going to need to replace it once we’re on the other side of COVID-19.

Anticipating the New Normal

The acceptance of working from home as a viable – dare we say effective – way for office workers to perform their jobs is almost certainly the most important shift to come out of our society’s response to the COVID-19 pandemic. Even as the economy continues to reopen, large numbers of those workers now appear to be unwilling to relinquish the flexibility and convenience of working from home. At least, that’s what recent polls have suggested. To what extent this continues to be the case going forward into the next few years, well… it remains to be seen. Nevertheless, chances currently seem slim that office workers will ever go back to spending eight or more hours a day, five days a week in an office building.

So, what will the “new normal” look like? I agree that it will most likely be a hybrid work model of some sort, with employees splitting their time between working from home or elsewhere and working in the office. If that proves to be the case, office tenants will almost certainly need less space in the future than prior to the pandemic. That said, they’re still going to need space. Even if their employees continue to work remotely part of the time, tenants will need to provide enough space to enable collaboration when they’re in the office, not the mention another concern that’s often cited, it’s much easier to cultivate company culture when employees are physically working in the same location. Some office workers may also have concerns that lead them back into the office more often than currently anticipated. Younger people, those early in their careers, tend to benefit greatly from casual conversations in the workplace. It helps them to “learn the ropes” and build professional relationships. Even more established employees can succumb to FOMO, the fear of missing out on critical intel, new connections, and opportunities for advancement.

Also included in the equation, social distancing measures will undoubtedly serve to reverse the trend leading up to the pandemic of greater and greater employment density per square foot. Simply put, more space is going to be allocated to each employee in the office post pandemic, perhaps more so than ever before. That’s good to keep in mind, but the key factor, estimating what percentage of the workforce is going to be in the office at any given time, remains elusive. In the 2022 edition of Emerging Trends in Real Estate – an annual publication that I highly recommend for its almost extreme thoroughness across property types – the majority of real estate professionals in this year’s survey agree that the hybrid work model is here to stay. Although fully remote work may hold some of its ground, most of the workforce is expected to eventually start reporting to the office three or four days a week on average. [1]

A Bifurcation of Adaptability

As leases in office buildings roll over the next couple of years, tenants will start shifting their focus from getting through the pandemic to implementing long-term plans. Companies will almost certainly be reducing the amount of space they lease, at least compared to before the pandemic. However, the space they do lease will need to be better. It will need to incorporate a myriad of appealing amenities and cutting-edge technologies, including highly effective ventilation systems, touchless doors, elevators, and light switches, and tenant engagement tools. In short, it will need to be modern and agile, with lots of services.

The office must become a destination with a purpose. Otherwise, why bother. If anything, that’s the lesson office investors should have learned from COVID-19. Businesses will have to provide working environments that are perceived as safe, healthy, and comfortable. That’s going to be vital in attracting talent and encouraging workers to come into the office on a regular basis. It’s a matter of dialing up the feel-good factor. Not only is it the right thing to do, it’s also a means to raising worker productivity and creativity in the process. The landlords of such buildings will more easily attract the best tenants because those tenants will more easily recruit and retain the best employees.

While chewing on that, keep this in mind. The United States is currently undergoing a generational shift, with millennials recently surpassing baby boomers as the largest demographic cohort. Millennials (born between 1981 and 1996) now account for more of the labor force than any other cohort. What’s more, this is taking place against the backdrop of an ongoing advancement of the United States into more of a knowledge-based economy. According to Deloitte, employment in the tech sector has been growing by 2.1% annually since 2001. That’s compared to a growth rate of only 0.4% annually for the overall labor market. [2] As this transformation continues to play out, office workers, whether they be working from home or otherwise, are progressively capturing a growing share of job growth. For companies in the tech sector, which are plentiful in Northern California and the Pacific Northwest, it’s more important than ever to be cognizant of the work/life preferences of millennials and subsequent generations.

(Sidenote: As a Gen Xer, I don’t much appreciate being passed over… but it is what it is.)

The increased focus on modern buildings, those perceived as flexible and promoting human health and wellness, is going to drive a flight to quality as tenants and investors alike seek out new construction or demand significant upgrades to older stock. This, of course, will accelerate the obsolescence of older office buildings with few amenities, ridged layouts, and outdated mechanical systems. Older class B and C properties that choose not to adapt to changing tenant preferences are more likely to struggle over the coming years due to declining rents and market values. They’ll eventually be akin to typewriters in a smartphone world, functionally obsolete.

So, Where’s the Opportunity?

With value-add opportunities waning in Seattle, Portland, and San Francisco during the run-up to the COVID-19 pandemic, an office reset offers the possibility of replenishment. The adoption of hybrid work models is going to render large segments of existing office stock less competitive in the market. It’s not unlike what has transpired in the retail sector over the past twenty years. Just as e-commerce has pushed brick and mortar retailers into putting more emphasis on customer experience, working from home will push companies – and their landlords – into putting more emphasis on worker experience in the office. Those office properties that adapt to this new normal should benefit from strong demand and command premium rents. That makes it an interesting time for office investment. With a lot of the offices out there becoming increasingly functionally obsolete, opportunities to acquire and repositioning those properties should increase going forward.

About the Author
Headshot of G. Evan Bennett

G. Evan Bennett is the Founder & Managing Partner of Anthology Capital, a private equity firm that invests in commercial real estate located in the greater Seattle, Portland, and San Francisco markets. He also currently serves as the Secretary General of the World Council of Experts at FIABCI, the International Real Estate Federation.

Headshot of G. Evan Bennett

G. Evan Bennett is the Founder & Managing Partner of Anthology Capital, a private equity firm that invests in commercial real estate located in the greater Seattle, Portland, and San Francisco markets. He also currently serves as the Secretary General of the World Council of Experts at FIABCI, the International Real Estate Federation.

[1] PwC and the Urban Land Institute, “Emerging Trends in Real Estate 2022,” PwC and the Urban Land Institute (2021), www.pwc.com

[2] Akrur Barua, “The Tech Workforce is Expanding — and Changing — as Different Sectors Battle for Talent,” Deloitte (2022), www.deloitte.com

Any views or forecasts expressed in the Insights section of this website are those of the authors or speakers and do not necessarily reflect those of Anthology Capital. All information contained herein was believed to be reliable when published. However, no representation or warranty, either express or implied, is provided in relation to its accuracy or completeness. This content is only intended for informational purposes and should in no way be construed as investment advice.


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