The triple whammy for office real estate


Zoom into the “where we are” map on Automattic’s website, and you’ll search in vain for a “our headquarters” icon. The large but low-key tech company behind WordPress and a host of other open source software employs people from Ghana to Greece, from San Diego to Seville. But its 2,031 employees, in 96 countries, are all working remotely – and always have.

Many companies, since the start of the Covid-19 pandemic, have rethought their use of offices. Many are now embracing “hybrid working,” with staff splitting their work lives between home and the office, though few have yet gone all the way to what Automattic calls a “fully distributed enterprise.”

It’s impossible to predict what the lasting legacy of Covid will be on work habits, but few bosses would dispute that it will mean less time in headquarters buildings for most office workers at big companies.

Unfortunately for those who own office buildings, this seemingly inevitable decline in office demand is set to coincide with an impending downturn in the perennial commercial real estate cycle – a downturn that could prove more pronounced than the seismic crash of 2007. 2008.

When the global financial crisis began to hit 15 years ago, the real estate asset bubble was one of the largest and one of the fastest to burst. Capital value in the London office market, a historic global real estate sector, fell by 25%.

Property markets have long been notoriously cyclical, but the recovery in recent years has been just as spectacular as this crash, thanks to consistently cheap financing and a desperate search for investment returns. Both factors were the result of ultra-low central bank rates, rolled out first to stoke the post-2008 recovery and then to avert a catastrophic downturn when Covid unleashed the world.

But as night follows day, the crash in real estate markets follows the boom. And with the Federal Reserve, Bank of England and European Central Bank now in tightening mode, estate agents recognize that the good times are over. Now it’s just a matter of how bad it gets. CBRE spoke last month of a “marked slowdown everywhere” thanks to the rapidity of the rise in interest rates, which had “taken us all by surprise”.

A third, ostensibly benign force is also at work. Efforts by governments and the investment industry to boost the green credentials of large offices have dramatically reduced the carbon footprint of the best new builds. But for investors, there’s an undesirable side effect: large swaths of the world’s existing office space don’t meet new, greener standards thanks to brown energy, inefficient heating and lighting, to poor insulation and poor provisions for ecological transport. Experts expect this category of assets to lose the most value during the recession.

How bad will it get? Interest rates are generally not expected to approach historic highs as the federal funds rate, which sets the bar for US borrowers, hovered between 10% and 20%. In the UK, even radical economists are only predicting a 7% rise.

But optimists about the office’s future may cling to an unrealistic scenario. They point in particular to a limited impact on office leases since Covid first hit two and a half years ago.

This picture of demand gives false hope: Leases are typically long-term with no easy break clauses, meaning it’s only now that an initial trickle of non-renewals is turning into something more worrying. . Three-quarters of New York leases, for example, have not been renewed in the past two and a half years, according to a recent SSRN study.

Recent analysis suggests that due to the extent of the overheating of the past decade and the pressures now being felt, the outlook for the office property market is actually quite bleak.

This SSRN document concluded that the value of office real estate in the United States could decline in the long term by 28%, or nearly $500 billion. In Europe, analysts at Bank of America recently warned of a likely 12% decline in office values ​​over 18 months, and major real estate groups including Brookfield and BNP Paribas have themselves signaled concern over to a strong sale (presumably with an eye out for potential bargains).

This cycle, like everything, will of course turn. And anecdotal evidence suggests that in addition to ultra-green buildings, those in inner cities, rather than commercial outskirts, may fare better, as employers recognize workers’ desire for human contact in a dynamic framework. Even Automattic’s “distributed” workforce meets in person once a year, but not in an office.

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