Covid-19 has transformed (in ways yet to be fully fathomed, let alone repriced at the asset level) the physical requirements of work. Despite talk of innovative new office models that include permanent flex-work, building retrofitting, and off-site “distributed office spaces,” and imply a “death of the office flagship,” new data from UBS Asset Management‘s Real Estate and Private Markets (REPM) Research & Strategy Team says the office (as a destination as well as a thematic investment) will live on…with some modifications.

UBS points to the results of a JLL November 2020 survey of 2,000 workers across 10 countries. While the study found that 70 percent of respondents want to continue working from home after covid (in fact, the number of work from home days is expected to double after the pandemic from 1.2 days to 2.4 days averaged across all geographies), it also revealed that endless remote work is not an unqualified good.

Go figure

Specifically, JLL found  70 percent of those surveyed actually–what?–prefer being managed in a physical office. Moreover, 70 percent said the physical office space was better for collaborating and running meetings, while just under 70 percent said work-related issues were better solved in the office than at home or in a third-party location. All of the above point to increasing prevalence of hybrid work schedules that combine remote and physical work capabilities.

UBS also points to a disparity in these kinds of survey responses that may correlate to seniority and income level. A May 2020 QuestionPro/Stanford University survey of 2,500 U.S. residents earning more than $20,000 per year who reported being able to work-from-home at some point during covid-19 found that a significant number–27 percent, more than any other segment–said they wanted to work from home 5 days a week after covid.

The same study found that the majority of the 27 percent who preferred to work from home 5 days per week held more senior roles, earned more money, and lived in larger suburban houses (implying long commutes for office face time, a desire for family/work-life balance, as well as ample space for home office setups). By comparison, the 10.7 percent of those surveyed who said they “never” wanted to work from home were almost all younger employees living in small, urban apartments.

Make the schlep worthwhile 

UBS expects that office real estate will have to change fundamentally to support greater demand for workplace flexibility. If an employee is going to commute into the  office, then the office space and the location itself needs to “add value” to making the trip. Rather than providing functional workstations, UBS says, offices will focus more on meeting rooms and breakout spaces designed to facilitate interaction.

This purpose-driven layout has long been a hallmark of technology office space, but post-covid, it could feature in other industries as well. Besides creating spaces for interaction, UBS notes, office space will become a “marketing tool” for the company vis-a-vis employees and clients.

Office location will also be key to value. This means a premium for close proximity to amenities and easy accessibility by public transportation, all of which can make the office schlep worthwhile, particularly for midlevel-and-senior management workers who may be coming into the office three days a week (rather than five). Workers advancing into those higher tiers of income and seniority may take the opportunity to move further from city centers, further adding to demand for amenities and infrastructure attractive to commuters.

ESG-ness 

Sustainability metrics will also be a key driver of commercial office values post-covid. UBS notes that office building environmental and sustainability credentials already rank among tenant must-haves. Many big corporate tenants (i.e., those who offer better covenants) have also made very public commitments to ESG goals, meaning that office assets will need to have strong ESG credentials to attract those tenants.

And there’s another catalyst in the Eurozone real estate market. As of March 2021, all funds marketed in the EU must assign themselves sustainability ratings (which also confer specific compliance requirements). What’s more, UBS says, the ESG characteristics of any future M&A deals in the European Union will become increasingly important, as the European Commission aims to achieve carbon neutrality for the region’s economy by 2050, and as EU and national parliaments alike rush to demonstrate their commitments to the Paris Agreement.

Are we looking at a “retail-type” real estate situation?

Furthermore, UBS says dire characterizations of office real estate as “the new retail“–i.e. doomed to secular decline–fail to take into account at least one significant difference between the two commercial real estate sub-sectors, at least in Europe (and possibly also applicable to the U.S. market).

“Office buildings have proved to be far more adaptable to changing demand trends in the past than retail,” UBS writes. “When office markets become structurally oversupplied, conversion to alternative uses is often viable, particularly in undersupplied residential markets, which most major European cities are.”

This differs markedly from retail floorspace, which are difficult to convert into an alternative use, due to their complex financial structures. After demolition (a costly process on its own), these properties are more or less reduced to the value of their land, making it (economically) infeasible to convert to other uses.
Making matters worse for retail, a chronic oversupply of retail office space has continued to grow as e-commerce has reduced the amount of retail real estate needed.

“Even if we are too bullish on future office occupancy trends, and the growth in working from home accelerates a decline in net absorption of office space faster than we anticipate, with a city center strategy we remain comfortable, as the residual land value of office buildings gives us a strong degree of comfort as we enter an uncertain environment,” UBS writes. “Unless demand for the office dies completely, we don’t envisage the same fate for the sector that the retail sector is undergoing.”

Winners and losers 

Ultimately, the analysts say, longer-term economic impacts of covid-19 will divide office real estate into winners and losers. The winners will be those in city centers, with close proximity to transport hubs (or in semi-central locations, in established office districts, with solid amenities and transportation connections), as well as those benefiting from major infrastructure developments (in Europe).

Office buildings designed around interactive spaces, enhanced HVAC systems, staff wellness facilities, and sustainable buildings with top-notch environment credentials will also command a premium. Flexibility to take additional short-term space as needed will be desirable, as will well-connected offices within “major mixed-use schemes with varied amenity provisions” (such as, they offer, London’s Canary Wharf).

As for the losers? You can probably imagine. These include purely functional office spaces that provide little besides workstations, located in poorly connected business parks with few local amenities, or in secondary markets where the jobs are mainly back-office oriented. Offices located in predominantly residential areas, and those with poor energy efficiency and environmental scores will lag, as will buildings with less leasable floor space and limited ability to reconfigure existing space.

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