Uncertainty in occupier demand reduces investor appetite for offices

Investors are finding underwriting office demand a challenge in the current environment. But once social distancing subsides that should change, according to James Jacobs, head of real estate for Lazard’s private capital advisory group.

James Jacobs, Lazard

While offices have traditionally been the largest sector exposure in institutional real estate portfolios, many investors are reluctant to allocate further capital to the sector at present. Demand is directly correlated to the economy and so, given this recession, it has fallen. Furthermore, the potential impact of covid-19 on office requirements, lease terms and location preferences are making it increasingly difficult for investors to underwrite the asset class at the moment.

Corporate occupiers in many countries have had the majority of their employees working from home over the past six months. Meanwhile, technology has enabled many firms to migrate, often seamlessly, to the virtual office. This does not, however, mean the end of the physical office as a place of work. Many employees, including those who do not have the luxury of appropriate workspaces at home, are keen to return. In addition, there are clear benefits of the office to businesses in terms of building client relationships, collaboration and training.

The demand for corporate space and the way in which offices are used will be driven by several considerations. Lower occupancy density, necessitated by social distancing rules, is likely to have a significant impact on the amount of space needed, as well as on the design and layout of offices. Many employees may adopt a hybrid working pattern, undertaking more solitary tasks from home and coming into the office for collaborative working. Given the possible evolution of these requirements and considerations over the next few years, we may also see a move to shorter, more flexible leases, which is challenging for core investors needing to meet longer term liabilities.

In terms of location, demand is likely to remain robust in the urban core. Many companies are expected to continue to cluster around suppliers, customers and clients and a central location will also enable businesses to attract talent from a wider catchment area.

Notwithstanding such demand, public transportation concerns and limited lift capacity in high-rise offices are likely to remain issues for as long as social distancing persists.
Given the current difficulties in forecasting occupational demand, investors may be hesitant at present to invest in offices. However, offices will almost certainly remain a fundamental part of corporate culture, to foster teamwork, collaboration and innovation. In due course there should be greater visibility over how offices will evolve, and increased investor appetite should follow.