Post-Pandemic CRE: Why Workspaces Will Still Matter
Businesses looking to stay at the forefront of their industries and markets need all the real-world returns that an office provides
Enterprise and employees alike may be embracing work from home for the time being, but the post-pandemic prospects for commercial real estate remain strong. With emotions running high, our natural desire to define the “new normal” mid-crisis has us catastrophizing when we should be brainstorming.
Office real estate will indeed face hurdles as we emerge from the global pandemic. The coming economic recession will almost certainly impact demand. However, we should be careful not to overestimate the impact of WFH based on the results of a four-month forced experiment. Demand for office space, and likely some extraordinary opportunities, will return.
Looking at the current market, there is a dearth in office leasing activity. Most firms are delaying major decisions on office space until the economy finds surer footing. Class A properties in major gateway markets owned by experienced and well-capitalized sponsors have a clear advantage in attracting reasonable financing terms in today’s market. Still, even for top assets, lenders have taken a prudent approach toward office properties by adjusting underwriting standards and credit spreads. Leverage requirements for offices have tightened from the 60 percent to 65 percent loan-to-value range to the 50 percent to 55 percent LTV range, while credit margins have increased 75 to 100 basis points during the pandemic. Pricing increases have been partially offset by the decrease in base rates (LIBOR and Treasuries), although most lenders have introduced floors to the base rate in the 25 to 50 basis points range.
Compared to other property types, office properties are still viewed favorably, especially compared to retail, which now faces the combined impact of the pandemic and continued growth in internet shopping. However, office properties trail when compared to logistics, industrial and multifamily, where there continues to be strong interest from the lending community.
Future of Office
The medium- and long-term impact of Covid-19 on office properties will be strongly correlated to the general economic recovery, rather than the vicissitudes of telecommuting trends. While companies deeply impacted by the pandemic may experiment with reductions in workspace, most others will continue to invest in office assets—for a number of reasons.
Premature predictions about the inevitable victory of WFH ignore key components of doing business. Over the longer term, the majority of businesses can’t thrive without the tangible benefits of the brick-and-mortar office. In fact, as billionaire Silicon Valley executive Eric Schmidt recently argued in Business Insider, most companies may eventually be in the market for more office space—not less.
Pre-pandemic, leaders and CFOs were clear on the countless advantages an exceptional office space can provide. Of course, having a great workplace helps advance organizational priorities—nurturing an outstanding office culture, attracting top talent and so on.
But offices also facilitate the perennial benefits of face-to-face contexts, including increased collaboration, enhanced innovation, closer relationships and meaningful mentoring. After all, as HubbleHQ CEO Tushar Agarwal said in an April 2020 Forbes article, “Humans are social beings, and in-person connections are hard to fully replace.” Even with recent advancements in technology, distributed workforce models simply can’t provide such connections.
Employees, themselves, are in agreement. A recent Wall Street Journal article chronicled the many things people are missing about their offices right now, from how they help us “put some guardrails on the workday” to the ways they provide “an escape from domestic life.”
Like all industries, CRE will confront a range of pandemic-related challenges. But, for businesses, all of these dynamics will still hold when we’ve moved beyond the present crisis.
Once we find our post-pandemic footing, offices may actually matter more than ever.
Take the putative strengths of telecommuting. Yes, WFH is working … for now. Established workers can address status quo tasks from home because we’ve developed some good-enough tech workarounds. Moreover, WFH is successful in the present context because society is essentially operating in a static state. When we return to a more dynamic work landscape, watch for evolving issues with new hires, skills, tech, interpersonal dealings and more.
In a world where we need to develop fresh strategies, build new connections, sell products, attract and train talent, and mentor staff, the WFH model falls apart.
New employees unquestionably need IRL (in real life) contact to adapt to a new workplace—and to integrate the expectations of the organization. And employees who hope to effectively drive groundbreaking projects may need to leverage people in the firm with whom they don’t yet have established relationships. In other words, businesses looking to stay at the fore need all the real-world returns that an office provides.
The pro-office arguments go far beyond just enabling work to proceed as usual. As we shift into post-pandemic mode, companies will find that investing in corporate workspaces offers key advantages on several fronts.
For one, the preferences of young companies and young talent converge in a propensity toward preferring a shared workspace. Millennials and members of Gen Z are known for their tech literacy. But these digital natives know they’re missing out on in-person learning and collaboration—and are drawn to companies offering unique, community-forward office environments.
New and growing industries catering to a younger demographic are likewise attracted to office-based ventures. Companies like Apple, which prizes in-person meetings, are banking on shared workspaces as the best place to conduct business. These leading-edge corporations are also betting that their distinctive work milieus will be a huge selling point with sought-after talent.
Finally, we will see some sectors leading the way on the crucial design and policy innovations needed to facilitate post-pandemic safety, connectivity and productivity. The advantages of starting with a blank slate have never been more apparent, since properties in development now will boast unprecedented agility vis-à-vis necessary post-crisis adaptations.
In-progress projects, such as the Olayan Group’s renowned 550 Madison, may be well- positioned to deploy such solutions. Erik Horvat, managing director of real estate at Olayan America, explains they are prioritizing health, wellness and space— with medical-grade air filtration, a seamless, touchless entry system, ample opportunities for employees to spend time out of their offices with amenity levels and outdoor space, and other noteworthy features.
“After spending so much time in our homes, we believe people will actively want to return to work spaces, and developers have to pivot their building plans to ensure they can do so comfortably and safely,” he says. “We have a unique opportunity to incorporate best practices from experts and designers for a post-COVID world.”
Office spaces that can be designed to appeal to emerging industries and demographics, implement sustainability, and/or integrate best practices for social distancing will dominate CRE in the post-COVID-19 era.
As we move beyond the current crisis, expect to see an office-space renaissance, courtesy of nimble businesses and building owners who are able to leverage new ways of managing these historically stable assets. CRE prospects will remain robust throughout the pandemic recovery, especially for those able to adapt to structural and demographic changes in the market.
Craig Bender is the head of commercial real estate financing for the Americas with ING.