With large numbers of white-collar workers staying home during the pandemic, the future of office and central business districts has become a major talking point in the investment community, writes Nedgroup’s Andrew Parsons.
Top of mind for those of us in the finance industry, as if it’s the only place where the world works, nevertheless it does represent a significant amount of commercial real estate capital, infrastructure and services which supports it.
Hot topic
Office has not produced the best long-term risk adjusted returns, the likely outcome of its commodity characteristics.
This is typified by significant price volatility usually caused by excess supply and major tenants able to extort favourable long-term lease deals by threatening current landlords to move to the latest tower offering more amenities, cleaner air, lower emissions, faster lifts, new foyers and the ability to cram more workers into less space.
Hence, Covid-triggered Work From Home (WFH) practices have become a hot topic as commercial space users grapple with the issue of how much space they actually need if a sizeable portion of their team seem capable of working remotely.
Saving commute time, more family time and a greater sense of being trusted by their manager has been a common theme in employee surveys, while being home to receive Amazon deliveries or for the tradesman to arrive has been an added benefit for many, with limited evidence of lost productivity thus far.
But there are drawbacks
The case against swathes of workers abandoning the office focuses on the inability to build team culture, lack of personal or team connection, peer pressure/mental health, the benefits of collaboration, learning and overseeing quality consistency.
Separating work from home seems a reasonable concern and often it is a difficult challenge for smaller living quarters, shared renting or families who don’t welcome some members of the household spending too much time at home.
If nothing else, the Covid WFH/Work From Anywhere (WFA) experiment underscores the increased mobility of the white collar workforce facilitated by shifting to a paperless world, co-working and the flexibility of laptops/tablets, wi-fi and the cloud.
Decision U-turn
Once again, the Covid experience accelerates secular trends that have subtly been taking place for decades.
Perhaps the recent positive experience will be enough to convince entrenched cynics that widespread WFH is sustainable.
However, we think it would be naïve to be hasty.
We recall the dramatic predictions of workplace changes following September 11 and Sars which were eventually discarded and the early adopters of WFH (including IBM) who eventually reversed course.
Ultimately, we are inherently social animals and hence the herd will likely gradually re-form, albeit in different patterns.
We believe a hybrid model is the most likely outcome and the need for hot desking, now dubbed “clean desking”, is even more critical in a world of greater flexibility.
Teams will need to come together periodically but it may not necessarily be five days per week.
Boundaries
However, while workers will be afforded a higher level of flexibility, they will need clear parameters.
It is instructive to see the comments of larger space users including technology companies which have been the major demand driver in office markets in recent years.
An interesting observation from Green Street Advisors during their collation of public comments, was that “a WFH ‘perk’ may be required by other companies in order to remain competitive in the war for talent”.
Combined with the impacts of economic contraction, we expect office demand in central business districts (CBDs) to be more muted in the short term at least.
Accordingly, we believe that having exposure to traditional commodity office space is not attractive at this juncture.
Bullet-proof investment?
However, not all office space is equally vulnerable and specialty office with higher barriers to supply remains attractive.
We recently introduced one position in the sector which we feel has compelling attributes.
Easterly Government Properties is a US office Reit which invests in US government tenanted properties, typically relatively modern with long term leases and some level of building specialisation that results in high renewal rate on lease expiry.
Among many government entities housed by Easterly are the Drug Enforcement Agency (DEA) and the Federal Bureau of Investigation (FBI), which both require slightly more robust security infrastructure than your regular office building, such as bullet-proof glass.
The company has a strong balance sheet, accentuated by the US government lease and low maintenance capital expenditure for an extended period.
We believe this is a robust cash flow and compares favourably with government bonds. We think we’ve found a gem.
This article was written for Expert Investor by Andrew Parsons, sub-investment manager on the Nedgroup Investments Global Property Fund.
