Workspaces Will Gain the Market in Post Pandemic CRE

David Cohn
Sep 1, 2020
CRE Market During COVID-19

Will offices still matter if this pandemic is over? Some commercial real estate experts seem to think so; in fact, they predict a boom in the workspace niche.

In this blog, we will summarize the points raised by several executives in real estate finance regarding this matter.

The gist?

Post-pandemic CRE prospects remain strong. Businesses that are serious about staying on top of their game will continue to appreciate the real-world returns that physical offices can provide.

Once the world finds its footing after this health crisis, workspaces will likely become more important than ever.

The limits of telecommuting

While many companies these days are embracing work from home (WFH) arrangements, the trend is not likely to last long.

WFH is working—but perhaps only for now. Many people can continue to do well-defined tasks from home for as long as they have access to the tech they need.

Moreover, WFH seems to be the better choice right now because much of society essentially operates in an inert state.

But when the world returns to a dynamic economic landscape, WFH will fall short—it will pose ever-growing issues in several areas, such as onboarding new hires, training, and more.

The WFH model is simply not good enough for developing fresh strategies, selling certain products, attracting and training top-notch talent, mentoring staff, and building genuine connections.

Less face time with peers and managers can still be a major roadblock in communication.

Zoom and other online meeting tools are simply no substitute for seeing people in the flesh.  Moreover, there are inimitable benefits to on-site collaboration, brainstorming, and innovation.

The WFH home arrangement also gives employers much less control over how employees use their time, leading to concerns about diminished productivity. And for employees that are on hourly contracts, it’s hard to ensure that paid time is truly spent on work.

And then, of course, there is the most obvious limitation of telecommuting: There are work functions that simply can’t be done from home—even among knowledge workers.

For example, certain IT problems are impossible to fix remotely. Many IT personnel can’t do their duties off-site because of security issues.

Regulatory requirements may also limit access to software, development tools, and other applications.

The current market

Many CRE experts agree that the predicted effects of the economic downturn on commercial real estate loans has largely been catastrophized.

It’s a result of emotions running high—of a desire to immediately define a “new normal” even though we’re still technically in the thick of the crisis. Instead of exaggerating the blow of the pandemic, the industry should really be brainstorming.

There is no denying that there are many hurdles for office real estate as the world emerges from the pandemic. The looming recession will certainly drive down demand.

However, it’s also important to NOT overestimate the effects of WFH. It’s wrong to assume that it will be the new normal based solely on what has happened in the last four months. It may not look like it now, but the demand for office space will return.

There is currently a decline in office leasing activity, and that’s not surprising. Most firms are understandably choosing to delay major decisions until the economy stabilizes.

That said, financing is still widely available for Class A properties located in key gateway markets, particularly those that are owned and managed by well-capitalized and highly experienced sponsors. But lenders are taking a much more prudent approach even for these top assets, by fine-tuning credit spreads and underwriting standards.

Leverage requirements for office properties used to be in the 60% to 65% percent LTV (loan-to-value) range. Now it’s in the 50% to 50% LTV range.

The pandemic has also caused credit margins to increase by 75 to 100 basis points.

The decrease in base rates has offset pricing increases at least partially, although a majority of lenders now have base-rate floors in the range of 25 to 50 basis points.

Still, office real estate is viewed more favorably viewed compared to other types of commercial real estate like retail, which now has to face the combined brunt impact of the health crises and the unstoppable growth of online shopping.

However, industrial, logistics and multifamily properties are doing much better than office real estate. These niches enjoy continued interest from lenders.

The future of offices

CRE experts think that the long-term impacts of the pandemic on office properties will correlate to overall economic recovery—not the changes in WFH trends.

Businesses that were deeply affected by the pandemic will no doubt continue to reduce their reliance on physical workspaces, but others will reinvest in office assets.

As a CRE investor, it’s important not to believe the premature prediction that WFH will be the norm.

This ignores key factors of doing business. The truth is, the majority of companies can’t thrive over the long term without the benefits of a physical office.

In fact, some Silicon Valley executives predict that most businesses will eventually need more office square footage—not less.

An exceptional workspace can provide countless advantages. It can help a company impress and attract top talent, build outstanding office culture, and much more.

Physical offices likewise facilitate the evergreen benefits derived from face-to-face interactions, including better collaboration, closer relationships, meaningful mentoring, and enhanced innovation. There are no two ways about it:

Humans will always be social beings. And despite the much-appreciated utility of online collaboration tools, in-person connections simply can’t be replaced.

Distributed workforce models are not able to provide that tangible connection no matter how high-tech the tools.

Employees agree. The Wall Street Journal recently ran an article about what people are missing about having an office, and many of them said that going to an official workplace put more structure in their workday. It also provided an escape from their domestic lives.

The rise of next-generation office properties

Here’s something interesting: CRE experts are predicting that the most successful companies will invest even more in building great workspaces as the market enters a post-pandemic era. Doing this offers many key advantages.

For one, these companies realize that a high-quality physical office will attract top Millennial and Gen Z talent, which seems to prefer shared workspaces.

These highly tech-literate generations certainly appreciate the convenience of WFH arrangements, but they also crave in-person collaboration and learning.

This is why they are drawn to companies that offer community-forward workspace environments.

Physical offices will also be important for new and growing businesses that cater to younger demographics.

Organizations like Apple, for example, continue to value in-person meetings and consider collaborative workspaces as the best venues for doing business.

Other leading-edge companies will likely follow suit as the dust from the pandemic settles.

Finally, crucial policy and design innovations are already underway to facilitate safety, productivity, and connectivity in post-COVID office settings.

It may be the best time to start with a blank slate—to build office properties that are designed with post-crisis adaptations.

The office of the future will prioritize health, space, and wellness. They will likely have medical-grade air filters, more open spaces, seamless and touchless access systems, amenities that encourage people to spend time outside, and other such noteworthy features.

Developers need to cater to a surge of people who will likely want to return to offices after spending so many months at home, ensuring that they can return to work safely and comfortably.

Workspaces that can be redesigned or built from the ground up to attract emerging demographics and industries, ensure maximum sustainability, and integrate social distancing best practices will dominate the commercial real estate sector in a post-COVID-19 scenario.

Investors can expect a renaissance in the office-space market, courtesy of future-proof companies, and office building owners who can take advantage of growth opportunities in this historically stable asset class.

CRE prospects should remain healthy as the world recovers from the pandemic, especially for industry players who can adapt to demographic and transformations in the market.