Is the office an analogue product in a digital world?
Is the office an analogue product in a digital world?
The Covid-19 pandemic has acted as a catalyst, accelerating a number of global trends. One of the most significant of these is working from home, a trend which is set to continue, even after the lockdowns are lifted. And with substantial numbers of people working remotely in the next few years, we believe demand for offices will be substantially reduced in the long term.
Covid-19 is accelerating disruption
Recent newspaper reports and various surveys suggest that many companies are seeing the benefits of employees working from home and will encourage it in the future. Advances in technology in recent years also mean working from home is now a relatively straightforward process and that employees are able to achieve similar or even higher levels of productivity at home as they would in the office.
Here at Schroders, 98% of the workforce has been working from home since the lockdown began, with no apparent drop in productivity.
The company’s new London HQ was designed with home working in mind. The office only has desks for 70% of the workforce and even before the Covid-19 crisis employees were encouraged to work from home at least one day a week.
Going forward, companies designing a new office complex may choose to cut this capacity further, possibly to around 50% or maybe even lower, as increased numbers of employees choose flexible and remote working for part of their working week.
Does this mean the office is dead?
Despite the increase in remote working, we don’t envisage a time when employees will work exclusively from home. Humans are social beings and interaction is essential in many businesses, particularly the creative industries.
As we all work from home, it is clear that the innovation generated when we collaborate and collude with colleagues is a void which cannot be replicated in the virtual world.
It is also important to highlight that if remote working were to continue for a substantially longer period this would affect businesses in a more marked way. In the short term it is easy to keep existing relationships strong over Zoom or Microsoft teams. However, in the longer term it will likely be detrimental to the formation of new corporate relationships.
It is for these reasons that we believe office occupiers will follow a ‘hub and virtual spoke’ model.
Employers will want a central ‘hub’ location for collaborating, training, talent retention and building a company culture. As corporates reduce their office footprint, offices outside of central, core locations may well become ‘virtual’. Secondary locations will not offer employers or employees the networking opportunities required and are therefore likely to become surplus to requirements.
Cities vs suburbs
While Covid-19 is accelerating many changes taking place in real estate markets, it is not going to stop urbanisation. The efficiencies that are created by cities are unrivalled. There will arguably be no rural revival due to Covid-19. Some businesses may chose to move from global cities to secondary locations, but they will be in the minority.
Any owner of offices in weaker locations will have less pricing power, they will be a price taker rather than the price maker.
Once a lease ends in a secondary location, the tenant will always have the ‘work from home’ argument to help with rental negotiations.
We believe the ‘hub and spoke’ model that has characterised business’ occupational needs for many years will move to a ‘hub and virtual spoke’.
In a Covid-19 world, whilst interactions will be fewer, they will need to be more meaningful.
Employers and employees will only want to take part in important networking events. These will only happen in established clusters of expertise. Cities will still provide all the essential ingredients for businesses to grow – knowledge, clients, capital, and connectivity. Cities will continue to be where businesses congregate and careers are built.
The office of the future could look very different
While we believe offices will continue to serve a purpose, their configuration, function and lease structures are likely to change. The main feature of this change will be a need for increased flexibility.
Before Covid-19 there was an increasing number of ‘core & flex’ office leases. This style of lease is set to increase dramatically as businesses demand more flexibility. A ‘core & flex’ lease describes a business occupying a smaller, core component of space that is essential for them to function, with the option to expand into more space if needed.
The ‘flex’ space is often referred to as an ‘accordion’ because it is able to expand and contract at the user’s request. Flexibility for tenants means that there will be less certainty over the amount of income achieved by landlords. This will hit both valuations and levels of debt that can be ascribed to assets. It will also reduce the value of assets that cannot generate consistent levels of income. Similarly, banks may reduce the amount of debt they are willing to lend against assets to compensate for the greater level of risk.
How will this impact office values?
For assets located in well connected hubs with knowledge and networking opportunities, there is unlikely to be any dramatic change. Whilst income streams may be shorter, they are likely to be resilient due to demand from tenants needing to be in key ‘knowledge economy’ locations.
In contrast, for office assets in locations which do not offer tenants any networking, collaboration or productivity advantages, the changes in demand and values will be dramatic.
The reduction in demand for office space is similar to the changes we have seen in the retail sector. Despite the growth in e-commerce and the success of companies such as Amazon, there is still a need for physical shops. However, technology has, and will continue to, reduce the overall amount of space needed.
It is the same for the office sector. We believe working from home five days a week is not sustainable for many reasons and so there will still be a need for office space. Technology has structurally changed how retail assets are used and the value of those assets. The office sector is about to go through a similar change.
Issued in the Channel Islands by Cazenove Capital which is part of the Schroders Group and is a trading name of Schroders (C.I.) Limited, licensed and regulated by the Guernsey Financial Services Commission for banking and investment business; and regulated by the Jersey Financial Services Commission. Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements. All data contained within this document is sourced from Cazenove Capital unless otherwise stated.