Denver, United States – When Facebook pledged to lease 67,800 square meters (730,000 square feet) of real estate in a former post office in midtown Manhattan in 2020, New Yorkers from the mayor’s office to street vendors to the city’s real estate moguls, cited the deal as evidence that the culture bureau was not going to be another casualty of the COVID-19 pandemic.
But the deal that Facebook (now called Meta Platforms) wasn’t the windfall the building’s owner, Vornado Realty Trust, portrayed in its marketing. In fact, it was later revealed that Vornado had agreed to pay Facebook $150 million as an inducement to complete the deal.
Despite the bullish outlook for global commercial real estate from the Big Four accounting firms, the effect of the pandemic on the office sub-sector – in many ways the flagship slice of the global real estate industry – has been profound. Incentives like the one Facebook got, rental holidays, government stimulus, and long leases (often seven to 10 years) typical of the office market have hidden the pain owners of this expensive real estate are feeling. .
“CEOs all over the world are wondering how to explain to their shareholders why 50-60% of their corporate real estate is essentially vacant,” says Nicholas White, co-founder of Smart Buildings Certification, an Amsterdam-based consultancy. . “They ask their CFOs for all kinds of data on which of these expensive properties to get rid of and which to keep. But it’s almost impossible to imagine that this won’t ultimately affect what they can charge for rent, their vacancy rate and ultimately the value of the properties.
Despite the realization that COVID variants like Delta and Omicron could continue to stalk the planet, the annual forecasts that global players like Deloitte, PwC, Cushman & Wakefield and others released earlier this year were cautiously optimists, a reversal from the early days of the pandemic, when empty offices had people talking about “the death of the office”. Opinions have moderated since the first year of COVID, and the consensus now holds that the “new normal” will still include many offices.
But how much? And what about the value of investments made before the pandemic. Commercial real estate is a hold-and-grow game in most regions, and many wonder whether assumptions of annual returns of 8-10% or even more, often driving participation in such transactions, can survive the COVID storm.
Real estate investment firm CBRE’s annual look at the Asian market was titled “Harnessing Growth, Navigating Uncertainty”. The growth he talks about is almost entirely in residential and industrial spaces (warehouses, storage, factories). While not quite dead, the office does not show much life from an investor perspective. “Many EC companies are focused on renovating properties and reallocating space to other uses to maximize value,” Deloitte’s global survey reports.
The retrofit often involves the reconversion of offices whose long-term valuation now counts as “uncertainty”, to use a formula. In some of the world’s largest cities – especially those suffering from a shortage of affordable housing – this has led some office building owners to enter a whole new market, ‘office-to-residential conversion’.
In the United States, the mismatch between office vacancy rates and housing supply is particularly acute. Property data company RentCafe suggests that tens of thousands of these conversions will be created from inert office space in 2022.
It’s not just in the United States. The City of London has announced a plan to create 1,500 new residences via such conversions amid burgundy bars and £100-per-plate ($130) dining establishments. Berlin, Durban, Hong Kong, Sydney and other cities are also seeing the trend. And while the numbers are low, they reflect the deteriorating outlook for office buildings.
Fall for the fish
Fears that office real estate will see a lease-less calm before the storm explain rental furloughs, free parking spaces and subsidized renovations like the ones Vornado offered Facebook in 2020. The Interest Rate Perspective higher is another blow, raising the cost of capital for everything from maintenance to tenant acquisition to the post-pandemic expectation that landlords will meet demands for sustainability and well-being.
“Many forward-thinking owners are getting this seismic shift in their thinking about the nature of space and leaning heavily in terms of technology investment to meet this new market reality,” says Michael Beckerman, CEO and Founder of the New York-based influencer. CREtech real estate study firm. “Those who don’t will clearly be left behind.”
The general picture is gloomy.
Office availability rates in Tokyo remain at pandemic highs, above 8%, from just 2% in 2019. Vacancies – a longer-term measure of empty space – in the city’s central business districts are expected to , according to Cushman & Wakefield, to hover around 6 percent through 2024. Indian cities saw new leases drop 39 percent in 2021; in Toronto, the figure for the downtown business district was down 47%, according to real estate database company CoStar. London’s office footprint fell by millions of square feet in 2021 as developers put projects on hold.
Nothing hurts a building’s valuation like low occupancy, which not only raises eyebrows among potential tenants, but produces less revenue to distribute to a building’s investors. REITs – Real Estate Investment Trusts – attempt to arbitrate this risk by grouping tens, hundreds or even thousands of properties into an indexed fund. This works well if values slip in one geography but still work in others. But the fear is that office real estate as an asset class is past its sell-by date. In a global pandemic, such arbitrage only works between asset classes.
Maurie Backman, a widely followed personal finance editor for investment adviser Motley Fool, says office REITs “is a sector I don’t want to touch anytime soon.” She’s not one to declare offices dead, mind you. But “there is little incentive for companies to rush to sign or renew leases when the world is still so unstable from a pandemic perspective.”
This uncertainty is causing a tectonic shift, not only in people’s realization that indoor spaces and density can be deadly, but also in a deeper reassessment of what it means to work in an office environment. . A lot, it turns out, a lot like working from home, running in the middle of the day, or never getting out of their pajama bottoms.
Business and landlord surveys confirm that while some are eager to return to the office, a majority want to retain the new remote working flexibility that the pandemic has imposed on management. Demographic trends in many markets have also accelerated this change, as young workers with no experience of 20th century corporate culture recoil from the conformity of the old suit and tie.
“Clearly not all of us are on the verge of returning to work as before,” says James O’Sullivan, who leads the post-COVID transformation team at London-based consultancy Project One. “We’re going to have to take our time to figure out which parts of our business are best suited to which ways of working. Some will be more suited to working remotely, others will be more back on site, and others will transition between the two.
And that kind of talk scares the incentives of commercial real estate owners.