Commercial office outlook: the disruption dynamic

Much has been made of the impact that big data, artificial intelligence and “the cloud” will have in disrupting traditional business models, but not of the seismic effect that it will have on the market for corporate real estate, writes Nick Judd, founder and head of investment at 90 North It will, though, have a real impact on both demand for and the value of office assets. What may have seemed a solid investment proposition five years ago may be unfit for tenant needs in the workplace market of the next decade. Investors need to pay attention. While location will endure as a real estate fundamental, the investment landscape has become significantly more complex. The emergence of radical new requirements mean that investors and tenants are aggressively seeking new types of business premises. There are relevant soft factors now in play that are currently having a material impact on demand for office property. With professional white-collar employment at an all-time high in many developed economies, and companies hunting for talent, organisations are increasingly looking to invest in “live, work and play” facilities to ‘host” their teams. This initially translates to very high demand for offices located in areas near to appropriate housing, leisure and retail facilities. It also materially increases demand for the right type of building; often brand new or substantially remodelled with strong environmental accreditation, providing wide, open floor plans and extensive on-site facilities such as crèches, gyms, in-house dining areas and, of course, flexible and collaborative workspaces similar to those found in the booming serviced office sector. While the increased investment to provide such an environment may be unwelcome, the payback to the tenant is considerable and will result in reduced staff turnover and greater productivity. If for example, an employee works for an extra 30 minutes every day – or is enticed to come to the office at weekends – then the compound annual impact on productivity is very material. This trend creates substantial new opportunities for real estate investors to position themselves for future demand by acquiring assets that meet these long-term tenant needs. However, existing portfolios may contain substantial risk, as, despite strong covenants, current stock may not be fit for future purpose. This can lead to significant mis-valuation on investor balance sheets and create substantial unanticipated capex requirements to renew or attract new tenant. Caveat emptor or, more appropriately in this case, investor beware. Additionally, any investment in new office developments needs to be evaluated based upon a business plan which factors in this emergent future demand dynamic. Substantial value can be added through sourcing assets that may be easy to transition from old to new style premises. But, in all cases, investors need to understand that tenant demand can be heavily influenced by factors outside of traditional corporate priorities. This is an important trend that will only accelerate.