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Down But Not Out: Why We Are Still Bullish on Offices and 4 Key Trends for Investors

Down But Not Out: Why We Are Still Bullish on Offices and 4 Key Trends for Investors 3

Down But Not Out: Why We Are Still Bullish on Offices and 4 Key Trends for Investors 4By Eli Randel, COO of Crexi

The office asset class has faced an uphill climb through the pandemic, as the cultural shock upended workplace norms and revealed just how much tech could enable employees to continue business function without being physically present. However, over two years of remote work has made it clear how essential offices are to many companies and employees for collaboration, networking, mental health, and feeling a part of a team and something bigger. Out of this dichotomy of tech-powered remote work and the desire for in-person work emerges compromise in the form of flexible offices.

Herein lies the rub: flexible offices are still offices. And while office properties are still navigating the aftershocks of the pandemic and facing the headwinds of a potential economic softening, they are an essential part of the economic landscape and work culture.

Here’s why we’re still bullish on offices in the long-term, despite clouds of uncertainty, and key trends that point to future success for investors.

1. Companies are increasingly opting for decentralization and its advantages.

In an increasingly tech-powered world, companies of all shapes and sizes are gravitating towards decentralized operations due to its many advantages. What was once an enterprise with a single headquarters in a city’s central business district can now exist digitally with employees dotted across the world, thanks to advances in digital collaboration tools and cloud-based software platforms.

The pandemic accelerated the adoption of these tech tools and remote work out of necessity; many organizations had to pivot quickly and enable their employees to complete their work. With the onboarding of these tools, many more companies realized they could expand their physical footprint to more cities.

Workers spread forth from major cities to suburbs and second and third-tier metros, taking their jobs with them to take advantage of cheaper costs and more space available during lockdown. Now, these employees still want a place to work outside of their homes, driving continued demand for some type of office.

Companies are adapting their total footprint to accommodate these migration patterns. They’re perhaps deciding to downsize their headquarters and instead pick up smaller space in other markets (i.e., four 15k square foot offices with four common areas instead of one 40k square foot space.) This spreading out benefits assets in these suburban markets, and companies will likely continue decentralizing to accommodate their workforce and attract geographically diverse employees.

Office decentralization in the form of multiple smaller offices with one or two headquarters – called a “hub and spoke” model – also exposes businesses to a diverse array of economies and less political risk or exposure to closures and regulations. An organization spread out amid different regulations or economic events is less likely to be heavily impacted than one in a sole location. For example, in the U.S., Los Angeles’ mask mandate ended only earlier this summer, whereas Texas was one of the first to accept COVID as a part of life in 2020. A spread-out workforce also could behoove organizations with specialized, regionally focused go-to-market strategies and save some costs on travel expenses.

Thanks to these benefits and others, decentralization is driving a growing demand for office space that fits companies’ need for flexibility.

2. Most businesses aren’t giving up on offices; instead, they prioritize flexibility.

Per a recent YardiKube survey, more than 90% of businesses responded that “in-office work remains essential to company well-being” and “they would either not change their office footprint [or] increase it in the near future.” And the return to work seems to be happening, though foot traffic is nowhere near 2019 levels. Recent Placer.AI data showed that the gap between 2019 levels and 2022 foot traffic is slowly decreasing, with August 2022 posting 17.4% more office visits than the beginning of the year.

Yet, on the other side of the pandemic, over two years of remote work in some markets have changed employees’ relationship with in-office work. A recent Gallup poll showcased employees’ growing preference for hybrid work, citing improved work-life balance and improved ability to work with and form relationships with teammates among the top reasons for embracing at least some time in the office.

Logistical challenges for companies who are demanding a full-time return to work – whether it’s Apple employees’ letter to stakeholders or a lack of desks at Tesla offices, as reported in a recent Washington Post article -are only making a case for office flexibility.

As businesses adapt to accommodate their workforce, a few things are happening. Traditionally, there were six people for every one thousand square feet, but safety is now essential, requiring tenants to expand their overall footprint with a less condensed workspace. This also has led to a flight to quality, with tenants seeking assets with improved HVAC and hygienic standards. On-site offices must also be fully outfitted with collaboration technologies to include remote employees.

Flexibility has also become a priority for many in-office workers and thus for businesses. In August 2022, Crexi reported an 18% increase in the amount of co-working space that came online, with the median time on the market shrinking from 70 days in July to an impressive 38 days as companies accelerate space absorption. In September, searches for office leases have increased in the top ten U.S. metros such as Houston, Miami, and Los Angeles, showing increased demand for office space as we transition to fall.

Demand for offices emphasizing flexibility is unlikely to go away in the next few years, despite economic headwinds. Given a few more years, we’ll likely see the trending line of recovery pick up speed, which leads to our next point: long-term opportunity.

3. Minimal development equates maximum opportunity when the time is right.

The Fed’s latest interest rate hike, an attempt to tackle inflation’s hitting its highest percentage in 40 years at 8.3% in September, obviously presents additional roadblocks to the average investor. Capital is more expensive than it was at the start of 2022, slowing down transactions and creating a bid-ask gap that’s pausing in-process transactions.

However, for those with cash, opportunity awaits in the office space in the form of future supply constraints. The last few years have seen minimal office market development due to the asset types’ uncertainty and the lion’s share of development dollars flooding into the multifamily and industrial space.

Office wasn’t getting as much attention and avoided an overwhelm of new supply, which is already causing slight corrections in those “hot asset classes” mentioned above. Because supply is limited,  an uptick in demand for offices will likely drive up occupancy, rates, and eventually valuations.

Here, a bifurcation is likely to occur across the quality of offices: a big corporation with liability for keeping its back-to-work employees safe will opt for more sterile, Class A/B buildings with plenty of space and natural sunlight. Conversely, entrepreneurial types and startups – a cohort growing at healthy rates and likely will continue if the economy sees corrections – will opt for the more reasonably priced Class C/D spaces.

If an investor has cash in hand, this could be an opportunity to get into the ground floor before sunnier skies reappear.

4. The economy is cyclical, and offices are a fundamental part of U.S. culture.

Try as cultural norms, new technologies, and pandemics might, offices are a fundamental part of the American economy. As mentioned in a 2020 Wall Street Journal article, we have worked at an “office” since the early days of the Industrial Revolution and have stubbornly clung to the concept ever since.

Human beings are organizational creatures at heart and thrive on the social aspect and community-centric experience that working in-office at a company provides. A dedicated space for work, where one can focus on tasks away from family or other distractions, makes a significant difference in work-life balance and productivity.

Employees distancing themselves from the social networking and sense of purpose involved with office life may be doing themselves a disservice. The feeling of being a part of something bigger, building real-life connections or mentor-mentee relationships, and getting to see the results of hard work go a long way to maintaining and supporting mental health and well-being. While many workers have indicated the perks of avoiding commutes and committed focus, there’s a give-and-take: flexible office situations offer the best of both worlds.

Despite economic headwinds and a potential recession, offices will return to popularity and retake their place as an essential component of America’s economic engine. Job numbers are still strong, with unemployment rates among historic lows of 3.7% in August.

Commercial real estate, too, has historically presented a safe, long-term investment in times of economic uncertainty, relatively sheltered from inflation and rising interest rates. What goes down must go up, as the saying goes – and while the timeline may stretch from one to a handful of years, offices aren’t going anywhere in the long run.

Long-Term Outlook

Office has faced its  share of challenges, as have the companies occupying them, in the wake of the pandemic and staring down economic turbulence. Despite this, the asset class isn’t going anywhere and will remain an ingrained part of commercial real estate. New technologies, demand for creative and decentralized space solutions, and the relatively limited supply will all position offices for a robust recovery in the coming years, and promising opportunities await the savvy investor with long-term vision.

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