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Short-Term Woes Could Yield Long-Term Wins for Alert Office Investors

Dec 02, 2020 by Marc Rapport
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In classic contrarian fashion, investors in office space might want to watch closely in the coming weeks and months for the opportune moment to strike some deals downtown.

Downtown office space is taking a beating during the pandemic, and there’s certainly a lot of reason to believe that working from home (WFH) is as much permanent reality as temporary trend, but there’s also reason to believe otherwise, especially for longer-term commitments in that segment of the commercial real estate market.

"Some of the markets likely to experience the worst impacts in the near-term (2021 and 2022) may also have the strongest demand over the next decade, potentially creating a unique buying opportunity in coming quarters," says a new report from MetLife Investment Management.

The authors of the report, titled "The Pandemic Pitfall: Short-Term Forecasts Could Drive Mispricing in U.S. Office," say they don’t expect working from home to have a significant long-term impact on office demand overall, despite the pinch it’s currently putting on the space.

The succinct, nine-page report, in fact, cautions against reacting to the short term and lays out variables that MetLife analysts believe are key to evaluating the outlook for short-term and long-term demand, including public transit/commuting, worker demographics, and occupation.

Public transit/commuting: The analysts think it will be the end of 2021 before people again feel safe using public transit, putting particular pressure on markets that depend heavily on that, including the New York City, San Francisco, Boston, and Washington, D.C., metro areas, where 30%, 17%, 13%, and 13%, respectively, of the commuting population go public. Compare that with 5% in Los Angeles and 3% each in Miami and Dallas.

Such markets may fare better simply because commuting in your car is safer than by bus or subway, the report says, adding this telling observation: "As of Sept. 18, 40% of employees in Dallas had returned to the office, versus just 10% of New York office employees, and we believe this divergence is already putting pressure on leasing trends in transit-oriented markets."

Worker demographics: "In our view, the most junior and senior employees are less likely to work remotely and are also less likely to adopt desk-sharing arrangements that could allow firms to downsize office space," the MetLife analysts write.

That’s because workers from the younger set tend to need more direct guidance -- and are more likely to change jobs, starting that process anew -- while the older group includes senior managers and executives who also need to be in the office for collaborative and supervision reasons.

Meanwhile, those 35-54 comprise the age group that the MetLife analysts feel has the most people likely to keep working from home after the coast is clear and to be willing to share desk space in exchange for the ability to keep doing that on a regular basis. They help provide the headwinds, as the report calls it, for short-term office space demands.

Income also has a lot to do with it. People with household incomes above $100,000 are historically 47% more likely to work remotely than those in the $75,000 to $100,000 bracket, the MetLife analysts estimate, and they say that’s not likely to change after COVID-19 is a bitter memory.

They point to Atlanta as a market that in particular is feeling the pressures of remote working on office-space demand in the short term, while Tampa and San Diego are two examples of markets better buffered from those headwinds.

Occupation: For the long term, look for markets that are heavy on life, physical, and social sciences occupations, as well as financial services, where working from home is unlikely, especially when it’s not a social distancing mandate. Meanwhile, areas heavily into tech jobs might be more vulnerable to WFH pressures, since they can for the most part be done remotely.

"This implies that a market such as Boston, (with its) life science and defense focus, may be better positioned than a market such as Seattle, (which) is more oriented towards hardware and software development, in the near term," the report says.

Central business districts and suburban markets

Now for the far term. The MetLife analysts say that central business districts (CBDs) are more likely to contend with the issues around public safety and public transit, giving them some stability in the coming months and beyond.

They don’t expect a significant uptick in suburban office demand. Instead, "As the pandemic subsides, we believe the pendulum will swing back in favor of CBD offices," the analysts write, citing "several decades of history" and the concentration of talent in those areas.

They forecast that Washington, D.C.; San Francisco; San Jose, California; and Seattle will sustain the greatest drop in short-term office demand (over 2021 and 2022) but also experience the strongest resurgence in long-term demand.

On the other hand, Miami and Tampa, Florida; Nashville, Tennessee; and Phoenix will have relatively stable short-term demand but softer long-term demand.

The Millionacres bottom line

"Suburban submarkets may exhibit short-term stability, but we expect CBD office submarkets to outperform suburbs over the next cycle," the MetLife report says, citing what it calls "overly negative" views of the long-term potential in a number of major markets.

The analysts cite office assets, "especially those with lease-up or near-term lease rollover risk," taking big hits in several markets -- notably San Francisco, Seattle, Denver, San Jose, and Washington, D.C. -- for the next 12 to 18 months because of short-term headwinds that are now depressing their market value and creating attractive investment opportunities.

Those hits mean lower prices for investors who know their markets and have confidence in what they see ahead.

All these arguments are food for thought for investors as you consider short-term plays -- perhaps leaning toward the liquidity and agility offered by investing in REITs, for example -- and longer-term investments in owning property, whether individually or through partnerships.

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