Jacobson: offices ‘won’t be a question of simply slashing rents’

Jeff Jacobson is leaving Chicago-based LaSalle Investment Management after 30 years, more than half of which he has been at the helm as chief executive. He was appointed to the role in 2007, just as one global crisis was taking hold, and leaves amid another.

While too much leverage and development characterized the former crisis, accelerating technology and societal-based occupier trends are characterizing the current one, with offices being an especially difficult sector to navigate. In the days following his departure, PERE caught up with Jacobson to hear how he thinks institutional practitioners will need to engage with real estate’s greatest ‘known unknown’.

You leave LaSalle at a pivotal time for institutional real estate. How do you read the current landscape?

There are broad, structural, economic trends happening right now that impact all real estate sectors in one way or the other. These trends are accelerating due to the pandemic, among other factors, and creating winners and losers across sectors and within sectors and markets. Technology has and will continue to be a huge driver of change to almost every industry and business model. Technology is changing all aspects of our daily lives including how we work, communicate with each other, entertain ourselves, shop, live, travel and access information and news, among other things.

The trends caused and enabled by technology, combined with other social and demographic trends, are not going away and require investors to be very thoughtful in answering the ‘what’, ‘how’, ‘where’ and ‘when’ questions in deploying capital.  Investors have always had to answer these questions in one way or the other. But the speed at which the landscape is changing and the consequences of getting the answers right or wrong have increased substantially. The increased volatility as lease lengths shorten and tenant stability weakens creates more extreme dispersion between winners and losers.

“There will be a lot of experimentation over the next few years as we emerge from the pandemic.”

Former US Secretary of Defense Donald Rumsfeld made the famous statement about ‘known unknowns’ and ‘unknown unknowns’. While not a terribly elegant phrase, it is a useful way to think about volatility and uncertainty in investing. ‘Unknown unknowns’, like the Covid-19 pandemic, are almost impossible to anticipate. These proverbial black swan events occur periodically. But it is hard to base your portfolio strategy around them. Instead, these events can best be protected against via more traditional risk management tools such as portfolio diversification, not overleveraging and keeping adequate levels of available liquidity.

‘Known unknowns’, like the economic disruption caused by technology shifts, are different. One can anticipate the world is changing even if you don’t know exactly how it will play out, and you can identify likely broad trends and how they may impact real estate. The key is to be investing in ways that can benefit from these broad trends while at the same time reducing your exposure to sectors and assets that could likely be disrupted by these trends.

Offices are surely the sector’s greatest known unknown right now. What are we supposed to think about its future?

What does the workplace look like for different industries and different types of employees in the next 10 years? People really don’t know. We can all speculate. Most of us believe it will be different from the past. There will be a lot of experimentation over the next few years as we emerge from the pandemic. Depending upon the industry, company and location, you will see employers trying work from home, work from anywhere, hybrid working models and many other variations and combinations. These models will have different impacts on both the total demand for office space and the type and location of office space demand.

“The chances are that the next decade will be more difficult for offices”

Over my career in real estate, the average amount of office real estate required per employee has consistently declined. For the most part, this decline was accomplished by a ‘sardine’ approach of getting more people into the same floor by eliminating offices and desk space. As we got down to 10 meters squared per employee or less before the pandemic, the ability to further increase density became very difficult.

The next phase of reducing space required for office-using employees is to reduce the number of people required to be in the offices on any given day. Technology, whose use was greatly accelerated by the pandemic, has allowed for remote working to be extremely effective for many companies and workers.

Consequently, my view is there are significant shifts going on. On the margin, reducing the average amount of space required for office jobs is going to reduce aggregate demand for office space. But I don’t believe the office is going away completely. What does that mean though? Is it a 5 percent reduction from historical trends? Is it 10 percent? Or 20 percent? Under any scenario, the change could be rough for many office owners. If you reduce aggregate demand and supply does not go away, it means vacancies go up and rents come down. That’s the law of supply and demand.

Even in a sector with rising vacancies, however, there will be a type of office that will attract people while another type will become truly obsolescent – like what has been occurring in retail where the technology driven disruption started much earlier. What do you do with the latter? Well, it won’t be a question of simply slashing rents by a certain amount to attract tenants. In some cases, these buildings will become functionally and economically obsolete. Many will have to be repurposed for other uses or be replaced by new buildings.

So, going back to my earlier point, how do people come back to work? I suspect there will be a lot of experimentation over the next couple of years. There won’t be a right answer for any given industry. How people will use offices will vary by industry and by company. That is the main known unknown.

What do you make of those who would continue to extol the virtues of offices, despite current uncertainties?

People talk up their own books in every industry. When you are committed to your industry, particularly in an uncertain environment, human nature is to assume things will come back and hope for the best. It’s natural and no different to what retail owners did ten-plus years ago when the cracks started to show there.

But we’ve been in suspended animation. The chances are that the next decade will be more difficult for offices. Nobody wants to accept a negative reality until that reality is thrust upon them. That’s not necessarily logical. But it is human nature.