With one event after another, the past few years have had their impact on economies across industries, challenged the way we do business, how and in what we invest, overall wellbeing and how we work.
Given all recent changes and challenges, how attractive is office as an investment asset class?
Dietmar Klos: Offices are in the midst of a major reset, depending on location, building age, green footprint, flexible space layout, and technological advancements. Going forward, investing in office space requires increased effort by leveraging deep local knowledge and resources to manage risk properly. Despite the current economic environment, record-high inflation and rising interest rates, there is still a significant amount of investment capital on the sidelines. More than half of US C-suite business leaders* plan to invest in commercial real estate by enhancing or expanding their real estate footprint, while two-thirds are either leasing or plan to lease suburban office space.
Investments into office buildings must align to broader societal and sustainability ambitions as part of future proofing the business. Today’s employees hold their employers to higher standards, and expect more in return for the hours they put in. This certainly includes ESG. Businesses had to make their carbon usage visible and measure transparently. We are making progress as an industry but not in the speed necessary and continue to lag responsiveness, despite being a major contributor of emissions.
The office itself is not going away. It will be used differently. Employee concerns are far more likely to be taken into consideration than pre-pandemic when it comes to space planning and work model set up. Employees now have greater influence due to a shrinking labor market and more jobs offering flexibility.
The “new” office must consider investments into technology, adjusted workplace design, sustainability, and the overall employee experience and well-being.
Mark Grinis: Overall, the office asset class has taken a dent as a result of new ways of working, the changing role of the office and sustainability. It is an expensive asset class that requires major investments to maintain a competitive, sustainable, and valuable office of the future. At today’s 85% occupancy rate* landlords have less pricing power, which is challenging current yields for some segments of the market.
However, there are interesting areas of business where people will create new asset classes, other than the ones that will likely become functionally obsolete and will convert into something more dynamic and valued by the community. Local laws are increasingly taking aim at lower quality offices. The barriers for renting c-level offices will meet the need for capex and significant upgrades. This will put pressure on the B&C (building and construction) space. We are already seeing that in transaction volumes in what people are buying. But how do cities rethink what those C-level offices are and what they could look like? We are talking to many city and government officials on incorporating changes in zoning laws for alternative uses such as low-income housing needs and options for property tax abatements to incentivize investments that are required by the private sector.
For many property owners, there is a wait and see approach on implementing ESG standards until specific reporting guidelines are issued. This uncertainty will likely result in bottlenecks once all move towards adoption at the same time. There will be a first mover advantage for companies that embraced ESG early on.
As a key message, the economic downturn will force leaders to make important decisions regarding their real estate portfolios — from investments to space optimization to workforce models.
Mark, you previously stated, employers need to earn the commute time of their employees. What are key initiatives to encourage a return to the office?
Mark Grinis: Shifting employee expectations as part of the “new normal” with a more flexible and diverse workspaces are key when exploring strategies to increase employee engagement and optimizing occupancy costs.
Individuals’ commute time is the number one friction point. A 1-2hr commute to get to the office in the city center is a significant sacrifice when people can reason virtual as a viable substitute.
The office experience must demonstrate its superior value proposition, otherwise HR will be placed in the position to continually reassess its remote work policies. All efforts must be mindful of sector, job function, mentorship, and department as there is no “one size fits all” approach. A company can have certain parts of the organization five days, and another fully remote. What is certain, is the need to transition from traditional office space to more hospitality business, with increased investments in physical spaces aligned with the type of work performed in the office.
Floor plan designs need to fit the businesses, incorporating a layout that is effective and resulting in a higher quality office, including collaboration and innovation centers and pockets of individual spaces, with the mindfulness of a workday that requires a multitude of spaces. Being a hub and collaboration center will be a real permanent fixture of the office role going forward.
Can you elaborate on the trending terms “hybrid working” and “workation”?
Dietmar Klos: In addition to increased investments into office improvements and redesign, 64% of surveyed executives* are either leasing or plan to lease additional suburban office space, so called ‘hyperlocal’ offices, often close to where people live. Incorporating a local flexible office network, is an interesting option to meet the demands of employees and provide opportunities for talent attraction and retention.
Over 20% of international assignees* found themselves working in locations without a local employment contract. We see increased demand for a cross-border working approach. Business policies and guidelines are already getting implemented, while country by country tax and social implications need to be considered. The overall workplace experience is not tied to one physical location anymore, particularly with enhanced technologies allowing to connect from anywhere.
Reducing office space in one fixed location and incorporate hybrid working, provides general flexibility, allows talent growth, and supports being compliant to carbon emission and sustainability targets. However, it differs from one market to another. Filters such as job function, industry, location, and culture play into the equation. We need to be careful of broad generalizations and avoid being overly prescriptive on what the solution might be.
What are further challenges and who will be getting ahead of the curve?
Dietmar Klos: With increased remote working arrangements, the need for accountability, such as workplace monitoring of employee output and standards, without invading on individual’s privacy will remain. Businesses are expected to continue investing in smart technology designed to track and monitor.
While various complex challenges present themselves to employers with more flexible working policies, corporate culture must remain a strong suit and should not be neglected. Demographics play an important role towards employee attitude and wellbeing. Particularly the younger generations, who work 3+ days a week remotely, tend to be least loyal and have a higher risk of terminating their employment.
Mark Grinis: If I go back a decade, e-commerce in its early stages wasn’t viewed that much of a threat to regional malls. In my opinion, we are going through a derivative of that again when it comes to the ability of working virtually anywhere and the expectation that we need to go back to pre-pandemic times. We have broken the model as the evolved technology tools have evolved to the point where we can work from everywhere. That freedom will allow employees to have more control to organize work and personal responsibilities. It doesn’t have to be home vs office only, as it will be a combination, much in the way in which we shop today. We must be mindful of that and be forward looking on how that will impact the office market.
Those who embrace flexibility and innovative ways of working will have increased flexibility themselves when it comes to hiring and engaging future talents. It is time for embracing change and developing work strategies that work for the employee and the company. For the next years, the countries and markets that have increased physical vacancy from new ways of working will need to work through some excess inventory and sublease space. Equilibrium will return, but also new opportunities will emerge to reimagine certain properties that can provide greater and more productive use for the communities they serve.
* EY2022 Work Reimagined Survey
This article was published in "Property EU".
