Investment Analysis

Office Outfitter

Changes in the office sector make investing less cyclical and more secular.

For commercial real estate investors, the office sector is in a classic late cycle phase. Traditionally, office net operating income holds up well late in the cycle due to long-term leases, which build up a large mark to market on the delayed ability to fully participate in a rising market. Now, however, a rigorous secular trend affects the demand for office properties that bears further examination.

In the battle to attract and retain top employees, firms are using appealing, well-located office space as a recruitment and talent-retention tool. This new dynamic especially holds true for tech firms, where a veritable war for talent is taking place. Battles are being won through appealing workspaces, flexible working environments, proximity to home, and improved amenities. 

The efficient use of space has meant that tenants allocate fewer square feet per employee, allowing upgrades to higher quality space for the same total cost. This talent-retention tactic has moved beyond the tech industry, changing the aesthetics, functionality, and culture of workplaces.

Traditionally, most tech-related companies were located in gateway cities such as San Francisco, Seattle, and New York City, with wide exposure to highly educated talent pools through strong university systems. As tech firms flooded into these markets, demand for workspace rose, as did apartment rents.

Alternative Marketplaces

Expensive rents, combined with new tech-related jobs that are outpacing the talent pool in these gateway cities, has created a spillover effect into smaller, demographically similar markets like Austin, Texas; Raleigh, N.C.; and Reston, Va. Tech companies have found that establishing smaller hubs increases employable workforces, greatly reduces rent, and decreases overall cost of living for employees.

The growth of computing power is a primary driver of the change. More work is automated through computers analyzing data, while discussing and collaborating on the output is a more significant component of each employee's time.

Whether new build or renovation, aesthetically successful office developments provide a collaborative, industrial vibe. Ceilings are up to 14 feet high, windows maximize natural light, and large tables place workers in closer proximity to boost collaboration. Significantly denser, employee spaces range from 125 to 150 sf compared to 300 sf during the 1990s.

But what modern offices lack in dedicated space, they make up for with collaborative areas. In-house cafés and breakout rooms with comfortable seating and recreational distractions are geared toward the new work culture dynamic.

The phenomenon of telecommuting is essential to the long-term trends affecting office space. Estimates suggest only 70 to 75 percent of a company's workforce is in a physical office on any given workday, which contributes to needing less physical office space.

Virtual Offices

Widespread connectivity, cloud computing, and digital services supporting a virtual office have enabled workers the flexibility to reinvent how and where work is done. GoToMeeting and Skype allow colleagues to chat “face-to-face” from different geographic locations.

Providers of rentable office, meeting, and collaboration spaces such as WeWork and Regus further enlarge the definition of work and workspace. Collaboration platforms such as Microsoft's SharePoint and Slack allow for virtual collaboration within an enterprise and promote the technological trend of dynamic, shared knowledge.

What does that mean for investors? Gateway and smaller markets attracting a highly educated, highly skilled workforce will continue to thrive. Urban office properties will continue to be in demand, as well as those served by mass transit or located near urban housing and amenities.

Open floor plans and industrial aesthetics will continue to replace the drop-ceiling spaces and cubicles of the 1990s. Cities that are not immediate markets for the highly educated, newly graduated workforce may suffer, though certain infill Sunbelt locations are capitalizing on steady demand and reasonable pricing. On the other hand, commodity suburban properties not accessible by mass transit or with outmoded, difficult-to-renovate interiors are rapidly becoming obsolete.

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Scott Crowe

Scott Crowe is chief investment strategist at CenterSquare  Investment Management in Plymouth Meeting, Pa. Contact him at SCrowe@centersquare.com.

 

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