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Future of Office Demand (Want vs. Need)

December 13, 2020

In early 2020, office managers and CEOs everywhere were forced into a situation none of them could have predicted. Employees that traditionally were not granted the leverage to have a work-from-home option, now possess the ability to prove to managers that this is a viable alternative to working in a brick and mortar, centralized location. But, most employees should realize this might not last forever.

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Working from the office won't soon go away, it will, however, change.

And potentially dramatically.

 

Among many other considerations, the obvious benefit to companies is the savings potential on rent.

 

A basic analysis that managers are currently developing is the impact on the bottom-line as a result of a change in employee productivity working from home compared to the potential savings in rent.

That is, despite the risk of productivity decreasing, the savings in rent may actually justify continuing to allow employees to work from home. And, it should be noted, that there may be intangible value associated with authorizing more autonomy to employees.

 

Employee morale is of monumental importance for predicting future productivity - especially in an economy with a high likelihood of recession whereby good mental health will come at a premium.

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The forced experiment of working-from-home has required employers to trust their employees to be productive and complete tasks with less oversight. The amount of autonomy granted to employees almost certainly would not have been transferred to the same extent in any other scenario.

 

As many managers have observed, their employees can be trusted to work remotely while maintaining a reasonable level of productivity. It is noted that quantifying employee productivity is difficult to do at the onset because their familiarity with projects and processes is fairly consistent with what existed in the office. That is, as new projects and employees are on-boarded with the passage of time, the corporate structure, designation of roles, and designation of tasks becomes more difficult to administer. Therefore, drawing concrete conclusions based on employee productivity data from 2020 may not necessarily be sufficient to conclude that working-from-home does or does not work.

 

It is also noted that working from home as a long-term alternative may or may not be appropriate for different companies based on differences in corporate structure and culture.

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The obvious next question is how these changes might affect the demand for office space.

 

It's my position that the demand for office space may not be negatively correlated with acceptable work-from-home productivity to the extent that many anticipate.

 

Companies may be considering the potential negative effects to brand image as a result of relinquishing office space. Those companies that weather the storm and do not materially change their office footprint may be perceived as more stable by clients and shareholders compared with competition exiting the market. If this is in fact a consideration for some office tenants, the lines begin to become blurred between real estate value and business value. That is, if a tenant does not fundamentally need the space, rather they're occupying it to enhance corporate image, a portion of the rent may actually be attributable to intangible value rather than real estate. In practice, this would be almost impossible to segregate in the rental rate, however, it's incredibly important when identifying the risk of a real estate investment alternative. 

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Real estate gets its value based on its ability to satisfy a need, typically a physical need.

 

Therefore, in the event some office space now appeals to tenants based on an intangible need, the physical real estate has an increased risk of occupancy. That is, it may not be physically needed to the extent actual occupancy implies.

 

Whereas pre-COVID office demand was perceived to be a function of need, post-COVID office demand may be more a function of want. This increases the underlying risk of occupancy across virtually all office properties. If a portion of the office market follows the scenario laid out, rental rates may not be affected as much as overall values on a relative basis.

 

In essence, the argument I'm presenting is that the risk associated with wanting something is much greater than the risk associated with needing something.

 

This dynamic shift in occupancy risk would potentially result in a significant change in capitalization rates and thus the value of office real estate.

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There are many other factors that will influence the office market that have not been highlighted or discussed in this post, however, all we can do at this point is bring attention to what issues may be at-play and prepare how to solve them.

 

I'd love to hear your perspective on the office market and where you think the opportunities and risks lie; please send me an email at mrohm@commonwealthappraiser.com.

 Michael J. Rohm, MAI, CCIM, R/W-AC, is a fee appraiser and real estate agent working throughout Pennsylvania.

He is president and owner of Commonwealth Commercial Appraisal Group and is director of valuation advisory and senior associate with Landmark Commercial Realty. Contact him at mrohm@commonwealthappraiser.com.

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