Office Demand After COVID: Threat or Opportunity for Real Estate Investors?

After watching their employees successfully work from home during the COVID-19 pandemic, a number of CEOs might plan to adopt that model permanently. While this may temper demand for office space, the long-term viability of the concept is unproven. To find out how it might all play out and what it means for investors, Chief Investment Officer spoke recently with William Pattison, head of real estate research at MetLife Investment Management, and his colleague Mark Wilsmann, head of real estate equity strategies.

William Pattison

Mark Wilsmann

MetLife has been investing in office buildings in the U.S. for nearly a century—it participated in the financing of the Rockefeller Center and the Empire State Building—and has been involved in developing significant office buildings in most cities around the country.

CIO: Working from home has worked for a lot of people during the COVID-19 pandemic, and some large employers plan to continue the practice permanently, potentially reducing their real estate needs. Do you see this working long term?

William Pattison: Over the last decade a number of companies have shown it can work for a short period of time—maybe one to two years. But as coworkers become strangers to each other, company culture degrades and departmental silos grow. So we’ve seen most of those companies bring their workers back, and we think that’s probably the best roadmap for what we’re going to see now. While office demand will almost certainly get worse in the near-term, we believe it will probably get better in 2022 or 2023.

CIO: What about companies that bring employees back to the office? Will they have to make changes?

Mark Wilsmann: In the short run, yes. We’re working with tenants in a number of our buildings that have been gradually reopening, and they’re all looking at redesigns that involve social distancing. Depending on the flexibility of their existing space, they may not be able to accommodate more than 50% or 60% of their people coming back. They’re also exploring issues around traffic flow, how people are allowed to use the common areas, and how touchless technology could make people safer when using elevators, doors and bathrooms.

CIO: What do all these developments tell us about office space demand?

Pattison: We believe the one development that could significantly move the needle would be new standards for worker spacing. If we now need 300 square feet per person instead of 200, that could create a lot more demand for office space. Our view is that this will likely happen on the margins, but that the majority of companies will not increase their square footage per employee.

CIO: How do you see all this impacting office building valuations?

Wilsmann: Uncertainty around demand and the willingness of tenants to do long-term leases, along with the possibility that landlords will have to spend more to make their buildings viable, could make investing in office space riskier today than it was before COVID-19. Being in a recession wouldn’t help. Overall, we expect valuations for office buildings will decline over the next 12 months or so.

CIO: How is that impacting your investment strategy?

Pattison: If we see a significant price correction, we think it could be an investment opportunity. What’s significant? This could all change tomorrow based on the changing relative value of other investments, but right now we wouldn’t get excited about generic multi-tenant office buildings trading at a 5% discount to where they were at the start of the year, and we would underweight the sector at those levels. We think discounts in the 10% to 15% range represent fair value, and we’d keep a normal weighting. But if the discount exceeds 15%, we’ll probably want to start overweighting the office sector. Of course, you also have to overlay that with considerations about which regions and types of buildings will be most desirable.

CIO: Which sectors look most attractive?

Wilsmann: The COVID-19 situation has accelerated some things that were already going on, like the movement out of high-cost, high-tax states into those that have lower costs and still offer a high quality of living. We also anticipate a growing demand for more open, flexible, creative office space that can be configured to the tenant’s needs. Another big trend, we think, will be around health and wellness in office buildings—everything from air quality to amenities that support health and well-being, such as fitness centers and outdoor spaces. We think office buildings in growing cities that have some of those features are going to be the most likely winners—as will buildings that have the flexibility to alter their layout.

CIO: So investors need to be selective?

Pattison: Our sense is that real estate investors historically have not been as proactive as they should be when thinking about which markets are likely to underperform or outperform during a downturn. This is a good time to bear down a little harder when analyzing potential investments .




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