We examine the future of commercial real estate and its implications for employers and employees alike.
In the three years since offices around the world shut their doors tracking to the Covid-19 pandemic, the workforce has shifted drastically, embracing remote capabilities. In the early days of the pandemic, the future of commercial real estate was challenging to envision following a boom in urbanisation that had not shown signs of slowing down. Fast forward to today, and workers have adapted to at-home setups, which many have opted to maintain instead of returning to office. In this environment, some could conclude that office space demand should wane, but commercial real estate trends are not that simple.
On a recent Double Take episode, we spoke with experts in the commercial real estate industry about their views on the future of this important asset class and its implications for employers and employees alike. Alan Pontius, Senior Vice President and National Director at Marcus & Millichap’s Office and Industrial divisions, said that the future of office space is still very much up for debate:
You have camps that believe the office of the past is gone for good – just forget about it. And you have at the other extreme, the camp that says, ‘just give it a little bit of time and things are going to look a lot more like they did in the past.’ Both are extreme views really to make a point. It’s going to be somewhere in the middle.Alan Pontius, Senior Vice President and National Director at Marcus & Millichap’s Office and Industrial divisions
He emphasised that this middle ground can be attributed to the varying needs of businesses according to their size and composition. A huge corporate player with a long-held real estate footprint in a major city is likely to have different considerations, such as whether to shrink or expand its office space, than a small to mid-size regional firm with one or two locations. This is compounded by the arrival of a new generation of younger people who may value physical office space differently from their managers. According to Pontius, “You have an employer view, you have an employee view; they are not always the same.”
Pontius said that many of the aforementioned larger corporate players have been eyeing modern, state-of-the-art office buildings in sought-after locations in an effort to appeal to their employees – a strategy that stands in direct opposition to early-pandemic era predictions of the death of cities. Jeremy Kelly, Director of Global Research at JLL, contended that this flight to quality assets for some firms, in a bid to attract and retain talent, is one of the emergent trends influenced by environmental, social and governance (ESG) initiatives. On the other hand, he observed a stark trend in the opposite direction:
At the macro level, there’s certainly been evidence of more distributed living, more distributed business activity. We’ve seen some move to more affordable locations, which has meant that selective second and third-tier cities, selective suburbs have probably been the big winners of this sort of reshuffling activity.Jeremy Kelly, Director of Global Research at JLL
Kelly and Pontius both emphasised that this new normal hardly dictates a singular solution and that the future of how and where employees work is still up for debate. The flight to quality assets in desirable, urban areas raises the question of what will become of older, less updated office space, which has seen a sharp decline in demand relative to more modern spaces built in the last five-to-ten years. Much of the outdated office spaces seem ripe to convert to a different purpose, like residential. Pontius cautioned that doing so is not as simple as it might seem:
The big conversation being discussed right now is conversion of older, dated offices into retrofitted multi-family. And that will happen, but it won’t happen across the board. Again, the basis or the physical composition of the structure won’t allow for it. If the physical composition of the structure allows for it, the basis in many cases will have to come way down to justify that conversion cost.Alan Pontius
While the possibilities for dated office space remain unclear, modern amenities of today’s higher-quality assets are just one component of their desirability. “Location, location, location” is as important as ever. Kelly noted that many central business districts and newer innovation-oriented hotspots are beginning to come back to life at a faster pace than other submarkets. However, he noted that it may take more than one business cycle for central business districts to redefine themselves in a new urban ecosystem. Central business districts, he said, will need to further increase their immunity by adopting a more mixed-use footprint.
Whether a focus towards modern and updated space, retrofitting old space or a move to more distributed living, the future of office space becomes more complicated by a looming potential recession, which is likely to mean a shift in demand for many firms as the cost of borrowing increases and the consumer continues to feel the pain of inflation. Sean Coghlan, JLL’s Global Head of Research & Strategy for Capital Markets, emphasised the importance of watching demand when evaluating investment opportunities:
We’re seeing economic shifts that will likely begin to impact the confidence in the demand side of that sector, but also in consumer confidence to go out and spend money. We should be watching very closely the demand side of the capital markets, which is impacted by shifts in the rate environment. Inflation is impacting how groups are under-rating the growth of potential cash flows on an investment opportunity. Demand in the capital markets is also looking at strategically which markets they want to be accessing, which sectors should they be accessing and growing in or decreasing their exposure to.Sean Coghlan, JLL’s Global Head of Research & Strategy for Capital Markets
Coghlan pointed out that, unlike the environment immediately following the 2008 financial crisis, in the continuously evolving post-pandemic environment, capital is likely to move quickly once dislocations become more evident in property investment market opportunities. Historically, there has been quite a solid correlation between shifts in employment conditions and shifts in office occupancy. With commercial real estate occupancy at all-time highs, along with a looming economic shift that is expected to affect demand and consumer confidence, the future of office space near-term occupancy remains to be seen.
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This is a financial promotion. These opinions should not be construed as investment or other advice and are subject to change. This material is for information purposes only. This material is for professional investors only. Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell investments in those securities, countries or sectors. Please note that holdings and positioning are subject to change without notice. This article was written by members of the NIMNA investment team. ‘Newton’ and/or ‘Newton Investment Management’ is a corporate brand which refers to the following group of affiliated companies: Newton Investment Management Limited (NIM) and Newton Investment Management North America LLC (NIMNA). NIMNA was established in 2021 and is comprised of the equity and multi-asset teams from an affiliate, Mellon Investments Corporation.