You might not want to think back to what it was like in June last year but I’m going to ask you to do so.
You probably weren’t in the office. More likely, you were at home, fighting for space on the kitchen table, laptop in hand as the kids argued over the iPad and the delivery driver knocked on the front door. If you were concerned that this was what the future looked like, you weren’t alone.
Almost a year ago, I wrote Has Covid-19 changed the commercial office investment case forever? The question was rhetorical. With people working from home and the virus raging, the future was uncertain in almost every respect. It was impossible to offer a view with any real certainty.
Still, there was enough concern over commercial office space as an asset class that, having done our digging, we felt able to reassure our investors and advisers. “WFH is a necessary but ultimately temporary step to combat the virus,” I wrote, “and unlikely to result in any wholesale move to remote work.”
I went on to pose four questions that were top of mind at the time. Thanks to virus control and the passage of time we now have more data, a few useful anecdotes and a better view of how to answer them. Here goes:
1. Will remote working become the norm?
It’s It’s definitely going to be more popular. Having already made it work during the pandemic, many companies now accept that a proportion of their workforce will be working from home (WFH) to some degree.
The primary concern among employers was the potential adverse cultural and productivity impact of WFH. At this point, the data is mixed.
A detailed McKinsey survey (What’s next for remote work) states that about 40% of surveyed US office workers claimed they were more productive at home than in the office. But in Australia, Investa head of research David Cannington cites workforce productivity falling 3% in the fourth quarter of 2020. As Cannington told the AFR, “Clearly there are some benefits to home-based office work, but increased labour productivity isn’t one.”
The difference of opinion is reflected even among global businesses. Whilst PwC has made WFH a permanent option for staff, Goldman Sachs CEO, David Solomon, dismissed it as an “aberration that we’re going to correct as soon as possible”.
As per the McKinsey report, the future prevalence of WFH will depend on the industry and the perceived productivity and cost-saving benefits. Finance, insurance and management, for example, have far more potential for WFH than construction, manufacturing and agriculture.
In other words, it’s complicated. Whilst the technology (largely) held up and most of us did our jobs from home with ease (avoiding the commute was a bonus) the binary nature of the media reporting regarding WFH adoption is misleading. WFH is not an either/or thing just as flexibility need not mean just WFH three days per week. Companies are embracing different working hours, including partial WFH days (eg, half days), and different workspace requirements.
The cultural aspects are even more complicated, which is perhaps why the 2021 KPMG CEO Outlook Pulse Survey found that “global executives remain apprehensive about a fully remote workforce”. Last year, 73% were looking to hire talent that worked “predominantly remotely”. This year, that figure has fallen to 21%. More significantly, just 30% of global executives are considering a hybrid model where “most employees work remotely 2–3 days a week”.
This supports my claim from last year that Covid was unlikely to provoke a “wholesale move to remote work”. That should comfort income investors. WFH will be more popular than before the pandemic but it won’t become the norm.
2. Is this the end of the office building as we know it?
Mark this one up as a “no” from the outside and a “maybe” from the inside. Externally, most office buildings will look much the same in the years to come. Inside, however, they might not. With some staff working from home and the adverse health effects of working in close proximity, companies are having to rethink their office layouts.
This New York Times story explains how Google is creating a post-pandemic workplace that accommodates “employees who got used to working from home over the past year and don’t want to be in the office all the time anymore”. In our conversations with industry insiders this is a common theme. In the words of the Financial Times, “Employers want new, high-specification offices to tempt staff away from their homes.”
There’s even an argument this will increase demand for high quality office space. According to JLL, implementing social distancing floorplans would entail a 50% increase in per employee space for most businesses. And the number one directive from that company’s forecast series – Tenant needs in a post-pandemic world – was: “Space design that offers greater dedication, privacy and separation from others.” Both require more rather than less space per person.
Obviously, this won’t apply to every or even most offices. But what we can say is that office interiors will generally start to look different as new layouts and fitouts are undertaken to meet health requirements and working expectations. As a result, newly constructed buildings with best-practise operational health and air-handling services engineering are likely to be in high-demand. The office itself isn’t going anywhere any time soon.
3. How will an economic slowdown impact the cyclical office market?
Across the commercial office market, demand is down 5-15%. In Sydney and Melbourne, vacancy levels have shot up. The same is true across major global centres. A recent Deloitte survey on central London office space suggested office demand will fall by up to 15% as people continue to work from home.
Recently, a tenant adviser told me of a client that needed 500sqm of space in Melbourne. He sent out a brief and quickly received 65 building and 115 space options, producing a shortlist of three. This is a tenant’s market where shorter deals are being signed and hand-back clauses are being inserted into contracts. In other words, it’s a great time to move.
For our investors and advisers, a distinction should be made at this point. The cyclical downturn is most harshly being felt at the lower-quality, often “secondary” end of the market. Premium and A-grade buildings in which AREITs typically invest are relatively less affected. That should deliver some comfort to income investors. As for B, C and D-grade buildings, they face a very difficult few years and a more challenging future.
4. Will the downturn lead to a fully-fledged structural demise in commercial office properties?
Given the above research and the experience of living with the pandemic over the past year or so, we can answer this question with an unqualified “no”. The office is changing but it is definitely not dying.
Although many employees value the freedom and flexibility of WFH, they also value the companionship and cultural benefits of being in the office. A Future Forum study of knowledge workers across six countries found that while only 16% want to be fully remote, only 12% want to return to the office full-time. A hybrid model, therefore, looks most likely for many businesses.
In part two we’ll examine the investment implications of these findings for income investors and discuss how they are impacting the office component of APN’s AREIT Fund.