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Long Term Ramifications on Demand for Commercial Offices

Out of the many things I have read, it was a post at Housing Wire that made me wonder whether we are thinking too much in the present and not stepping back and referencing back to the baseline.

Real estate are traditionally less correlated with the equity markets. This time they are really showing less correlation. Various segments are dying together with the equity markets bar a few real estate segments, who are thriving instead.

Tenants have zero revenue and therefore cannot pay rent. The whole chain of parties from landlords, corporate lenders, shareholders, suppliers are all affected.

Many commentators are saying people in history will reference the period before Covid-19 and post Covid-19 as a pivotal period where all things change.

I think they are right but like always it is the extend of the change that may matter more. One of the tough thing to do in investing is valuing businesses because the nature of the business changes and this affect the intrinsic value of the company.

Usually, we are able to put our money down when we have higher conviction. Usually, certain aspect of that company we are certain about. What Covid-19 did was to make us question whether what was once certain will continue to be certain after this or will change entirely.

The real estate sector have been certain for a long time. Even within the sector, there are changes in trends. However, they take place in a past that every stake holders can adjust to.

Now, everyone seem to think that with work from home, there are no need for offices. I think there will be moderation, but this is not new. It will be the pace we are talking about.

Even with 10-20% overall vacancy will kill the valuation of certain property portfolios.

How big will the effect be? I am not sure.

In this post, I pulled together some of the things I have reader on this subject. I will list out some of the main points that stood out to me.

Everyone Down the Line is Affected

Animal Spirits: Investing in Corporate Real Estate >>

An interview with the manager of a USA ETF that focuses on triple net lease REITs, or REITs whose tenant pay for almost all the costs. I first shared about the appeal of net-lease REITs in this post here.

The parent company of the ETF is collaborating with huge asset manager Brookfield Asset Management to carry out sale-and-leaseback deals to help businesses that are hit a deal with cash flow better.

While there are aids provided by the government, it is not enough. The banks are not lending out as they should.

Some of the triple net lease REITs were affected because the tenants are Restaurants, Gyms, Day Care.

Surprisingly multi-family homes may be affected in the long run because of people relocating to other cities.

The appeal of net lease properties is that the tenants have long term contractual obligations. The tenants cannot break the lease easily.

The net lease REITs are taking the approach of working with their tenants to defer the rent, and then amortizing the rent over the rest of the contractual terms.

Everyone becomes a loser:

  1. Tenant cannot pay the rent
  2. Landlord takes a hit
  3. Corporate borrowers take a hit
  4. Shareholders take a hit as well

When tenant goes bankrupt, everyone down the line takes a hit as well.

In order to invest, you have to believe that in the long term, things will go back to normal.

That is, you will drop off your kids at day care, you will go to restaurants to eat.

They are seeing business picking up in different industries. Consumer behavior changes and so does how business is carried out. And so the revenue are recovering as well.

They also observed that suburban real estate is really growing.

Facebook CEO’s Future Office Policy in Full

Ramp Capital LLC: What we can learn from Global Workplace Analytics

The Death of Cities >>

Accroding to Gallup, Americans don’t want to live in big cities, they want to live in rural areas. The reason they live in big cities are for jobs and opportunities.

Data from Global Workplace Analytics:

  1. Only 3.6% of U.S employee workforce currently work from home 50% of the time or more
  2. 43% of employees work from home with some frequency
  3. 56% of the employees have a job where at least some of what they could do could be done remotely
  4. Studies show desks are vacant 50-60% of the time
  5. 80% of the employees say they would want to work from home at least some of the time
  6. 35% of employees would change jobs for opportunity to work remotely full time (Millennials much more than Boomers)
  7. 37% of employees would do so to work remotely some of the time (Millennials much more than Boomers)
  8. Greater than 33% of workers would take a paycut of up to 5% in exchange for the option to work remotely at lease some of the time. 25% would take a 10% paycut. 20% will take an even greater paycut

Moving to suburban places are more appealing. The rents in major cities are too expensive.

The cities with affordable housing and zero state income taxes may become very appealing to educated and rich workers.

On Facebook’s new policy: If you move away from the city, you are most likely to take a pay cut. There are trade-offs and you have to think about it. It might just be worth it still.

Major tech firms may not need to be headquartered in big cities. This will not kill the cities but will set growth back.

We may see tech firms moving to the suburbs. It will depend on whether the firms take the lead. The workers will follow.

The Increase in Remote Work or Work from Home Job Searches

WSJ: For Many, Remote Work Is Becoming Permanent in Wake of Coronavirus >>

“Just as Intel, HP, and others originally defined how we operated for decades in tech, we’ll see a redefinition for the 21st century by new digital companies.” – Aaron Levie, CEO and co-founder of Box Inc

LinkedIn recorded a 28% increase in remote job postings and a 42% increase in searches using the terms “remote” or “work from home”.

“The response to the pandemic has revealed the viability of remote work for many businesses that had access to the necessary technology, but were hesitant to expand the practice.”

The physical desire among humans to be physically present is hard-wired inside of us.

Jeffry Carter, General Partner at West Loop Ventures: Work From Anywhere >>

The last 10 years have seen a move towards urban city center vertical office campuses. Things might change so that worker can get outside in a less crowded space.

“You strip out a commute and you strip out having to get on an airplane for business meetings and you kind of remove a lot of these other things that crept into the work that you had to do.” – Aaron Levie

Conferences and meetups have more value compared to when on Zoom.

There are things that happen spontaneously in offices because people are in physical proximity with each other. These are the random stuff and conversations and comments. These spark ideas.

Even before Covid-19, CEO have a problem recruiting for their offices in areas like San Francisco, Los Angeles, NYC and Chicago. They were looking for a way to leave or reduce their headcount there.

Covid-19 gave them the perfect opportunity.

There are states that wishes to raise more taxes and there are states that are more “free”. Migration by firms may take place and this may impact not just state policy but also federal policies.

Since 2012, Jeffry have been noticing a trend towards co-working. Home space tends to be too cramped up. It may not be WeWork but other companies will take its space.

Avoiding Our Cognitive Bias to the Analysis of Larger Homes and Office Spaces

HousingWire: Could the coronavirus crisis lead to larger homes and office spaces >>

There are predictions that home size and office space have to increase but may be predicated upon the assumption that the prospect of a viral outbreak is the only factor a buyer considers.

Owners can have 50% of workers that are productive working from home to work from home and another 50% to work in office with better spacing. This may mean status quo.

Long term productivity is also unknown.

“The Spanish flu wreaked havoc on the U.S. economy, and many predicted it would lead to a decades-long recession – but instead, the pent-up demand to spend and enjoy life spurred the roaring 20’s. No one has a crystal ball to tell the future. But we do know that cultural change is usually slow, methodical, and the result of many social inputs. The accuracy of any prediction is incumbent on capturing as many of those input as possible and avoiding the cognitive bias of “What you see is all there is.”

Mass Commuting and Singapore Office

Mass telecommuting will shake up S’pore’s CBD, end work and office life as we know it>>

Human resources technology start-up EngageRocket, the Institute for Human Resources Professionals and the Singapore Human Resources Institute — has gathered more than 2,700 responses on workplace sentiments in Singapore since April 13.

  • 8 in 10 employees in Singapore wish to continue working from home at least half the time or more after the circuit breaker
  • 40% of younger workers said they were less productive than before. 49% of older workers said they were less productive than before
  • Companies cannot just manage employees based on face time
  • Peak hour traffic might be a thing of a past
  • Grade A office rent will get affected short term
  • Companies will fold or they might have multiple offices around Singapore
  • Office space might be re-design
  • The retail shops, Gyms catering to office crowd are badly affected as well

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Monday 25th of May 2020

Thanks for this, the animal spirits podcast is interesting. A triple net lease ETF is a cool idea.

I don't think things change so much in the long term. I believe there will be a vaccine or the virus mutates to become a normal flu. People will go to restaurants, childcare, gyms again, like after previous pandemics. Office usage may be reduced.

Cinemas look bad though. Dreamworks discovered they can release a movie online with record results. Studios may no longer have a theatrical run. AMC boycotted them, but I think AMC dies slowly anyway.

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