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💼 Cautious Office
briefcase | invest smarter | issue #109
We got some pushback from last week's newsletter because of some salty language. To be fair, we aren't the only ones. According to the Financial Times, we've reached peak swearflation.
It's OK though, the good folks over at the Fed will be banning the following words: Gosh, gee, golly, dagnamit, darn, drat, zounds, heck, cripes, and our personal favorite, gadzooks.
Thanks to the good people over at Alts for f'ing the heads up.
🧑🏻💼👩🏾💼 Post Office
No, not that kind of post office, although both are a bit antiquated.
The traditional office space sector is undergoing a once-in-a-lifetime paradigm shift. Pre-pandemic offices boasted 95% occupancy, now that number sits at around 47%, even though we are well passed pandemic lockdowns.
The office space is so disorganized that even President Biden can't find the rest of his classified documents.
Speaking of trainwrecks, let's talk a bit more about why the office space is in trouble.
The first major headwind for the traditional office model is that the pandemic has proven that a good chunk (about 50%) of the 140 million jobs in America can be done partially or fully remotely.
Only two in ten workers currently work full-time in the office, and a mere 6% say they want to work entirely on-site in the future.
As vacancy rates continue to rise, this cold hard truth has dire implications for traditional office space (samesies for Canada).
Triple Whammy
Couple this remote work headwind with the reality that we are entering troubled economic waters over the next few years. Rising inflation and debt costs will add a second burden to offices nationwide. Overall, the macroeconomic situation portends reduced corporate profits for the foreseeable future.
Less profits = cutbacks on personnel and space.
Now, many may tell you that the impact on office space has been minimal and that it will rebound. We say...
But, the triple nail in the office coffin is leasing. The lifecycle of an office lease is generally anywhere from 3-7 years. This creates a lagging effect on the asset class as a whole, meaning more pain is coming when those leases come up for renewal.
Think big companies who are suffering through recessionary pressures and half of their workforce can be partially or fully remote will keep the same size office?
TLDR: Remote work plus downward economic pressure on company profits (recession?) means certain office assets are in serious trouble. Multiply that by longer lease cycles, and we are possibly in for an office apocalypse over the coming years.
Even the TPS reports won't save us.
Sure thing Bob. I'm not even sure ChatGPT (aka the Terminator) can save you, but let's ask.
🙋🏼♂️Q: What is the status of the office market?
🤖A: The office market is very interesting right now. With the work-from-home trend, the market is shifting from large office spaces to more of a shared desk setup. Businesses are seeing that they can cut back on operating expenses if they switch from a large office building to several local shared office spaces.
🙋🏾♂️Q: Is the traditional office dead?
🤖A: I think the traditional office is dead. People are getting away from the typical 9-5 working office model and enjoying the flexibility of working remotely or from a shared working space. An office is no longer a place where people come to do work, but a flexible space where people can come together to collaborate and share ideas.
🙋🏼♂️Q: Why was Office Space such a good movie?
🤖A: The movie Office Space was such a fun movie because it hit on many things that people deal with in the workplace. The characters in the movie are relatable, and we've definitely all dealt with a Milton or a Lumbergh. The scenes in the movie are so over-the-top, but they're also true to what happens in an office. Office Space is a classic because it's just so funny and real at the same time.
There you have it folks. And if you don't know what a TPS report is, you have some homework to do.
Moving on...
Offices: Not Created Equal
To encourage workers to return to the office, employers and landlords must offer a best-in-class workspace with amenities. For higher-end office properties, the hybrid hit hasn't been as painful.
According to Deloitte, class A office buildings are currently selling for $50 more per square foot (15%) than pre-pandemic, despite the downturn in the market.
The office buildings of lower quality though, are in for some serious trouble.
Amenities and experiences are what's doing to set the tone for the reshuffling of the office market. Or, as Matt Knight eloquently put it:
That’s the fundamental truth that most office landlords underestimate or don’t understand - you think you provide a shiny building at a sexy address with irreplaceable amenities. You don’t. You provide a workplace experience.
In the end, the new reality is decreased demand. According to a Colliers and CoreNet Global survey, most corporate real estate professionals believe that hybrid work will produce less demand for office space this year.
Further, 71% believe that hybrid work trends will cause office space demand to shrink by at least 20%, and another 19% expect a space reduction of around 40%.
Similarly, PwC found that 10-20% of the current office space will need to be repurposed or removed from the market in the coming year. Repurposed to what? Housing? Sure, great idea, but this just isn't happening due primarily to long and expensive rezoning requirements.
Don't get us started on zoning!
Finally, according to another academic study, there was a 45% decline in office values in 2020 alone, and another 39% drop is on the way. This represents a value wipeout of $453 billion!
That's a lot of billys.
So What? Perhaps we are entering an era where we see sustained widespread abandonment of lower-quality offices, as we did in the 1920s with factories due to deindustrialization.
Deofficespacialization? We'll work on a better term.
Anyone with exposure to traditional office space who doesn't pivot is in for a world of pain. But where there's chaos, there's opportunity. Savvy owners and investors can implement new office models and conversions to pivot assets and avoid becoming a post office.
Alright, you can have the traditional office, but keep your f'ing hands off my stapler.
Weekly Real Estate Stories
🔁 Housing Turnaround? Don't expect a market turnaround in 2023 — HW
🔁 Mortgage Turnaround? Yup. Mortgage applications increased almost 30% week over week — MBA
📉 Rents: Continue to decelerate, falling 0.3% from November to December — Zillow
📊 Renting: Will be more affordable than buying in 2023 across the U.S. — ATTOM
🙋🏼♂️ Rent-to-own: 55% of Gen Zers and 37% of Millennials are willing to enter a rent-to-own agreement — NMN
🏘️ Housing: Price growth continues to stay stubbornly high, increasing 9.2% in Q4 2022, but down from Q3's growth rate of 13.1% — Fannie Mae
👀 Buyers: Are increasing, peaking their heads above the hedges like a creepy neighbor — Redfin
👷🏻♀️ Builders: Are getting happier, the sentiment index rose by 4 points in January — CNBC
Up next, on briefcase...
...The worst part of waking up from a nap is the noise my coworkers make.
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