THE OFFICE APOCALYPSE

Investors BurIed theIr heads in the sand as retail died. Office buildings will likely meet the same demise.

The death knell for the retail sector was a long time coming. Cracks in its foundation began to emerge about a decade ago, as ubiquitous American malls and big-box stores started shedding customers to e-commerce giants. Landlords across the country scrambled to lure customers back by devising ways to turn simple shops into customer experiences and opening in-store restaurants and galleries. Then, COVID-19 hit, and even these experiential strategies couldn’t save retailers. Customers grew wary of indoor activities and gained comfort shopping online, dealing an irreversible blow to physical retail.

Retail REITs reported a 23.6% decline in funds from operations in the last quarter of 2020, per the National Association of Retail Investment Trusts. But reports from institutional investors, listed retail REITs, and large landlords painted a much rosier picture.

Relative to the massive loss of value, there has been surprisingly little forthright acknowledgement of the true extent of the carnage from key stakeholders including pension funds, life insurance companies, and other institutional investors. Despite their purportedly conservative approach to managing “other people’s money,” they did not divest from retail assets in any significant way. A combination of factors may explain why they have buried their heads in the sand -- assurances from fund managers earning fees, a dearth of clear reporting, or a lack of knowledge of what’s

RICHARD RUBIN richard@therepvblik.com

Richard Rubin is the Founder and CEO of Repvblik, specialists in adaptive conversions and reuse of distressed commercial properties.

going on at the coal face. Only those shorting the market say that retail is dead.

Our cherished in-person activities will likely resume as the pandemic abates, but with much higher perceived hurdles. Now, we are spoiled for choice. We can watch movies from the comfort of our own homes, get our favorite dishes delivered to our doorstep, and order appliances that are delivered and installed the next day. The writing was on the wall for physical retail ten years ago, but its demise only became clear amid a global shutdown, cementing what is now commonly known as the “retail apocalypse.” For commercial office properties, a similar trajectory is afoot.

Not Worth The Water Cooler Gossip

The pandemic unquestionably shifted the way work gets done. Corporations were forced to either adapt or die. Federal programs helped buoy certain businesses, but ultimately had to accept that many folks would be working remotely or not at all. Only essential workers in most countries were permitted to work in-person at various junctures, and now, the emergence of the Delta variant coupled with vaccine hesitancy threatens to claim many more lives.

Work as we know it is changing permanently -- not unlike what happened to the retail sector. Commercial office buildings were once symbolic bastions of financial power to woo clients and to lord over competitors, shaping corporate culture. Employees had to plan their commutes, find childcare during the week, and painstakingly schedule meetings accounting for physical constraints. Now, many have discovered they prefer working from home, and research shows productivity has risen as a result.

Corporate tenants probably won’t miss having to pay rental and office overhead costs if their offices stay remote. As for workers themselves, they might find it a relief not to waste hours commuting in traffic or buying pricey office attire just for the meager thrill of water cooler gossip.

THIS TIME AROUND...

Of course, this is a gross simplification of certain aspects of office life. But many companies are preparing for remote or hybrid work to become the norm. Tech companies like Twitter and Slack have declared most of their workforce permanently remote. The US federal government is reportedly shrinking its office footprint, and so is JPMorgan Chase, one of the country’s largest landlords. 74% of Fortune 500 CEOs expect to reduce their companies’ commercial office space, per a June report. Companies are largely realizing they can get things done faster and with less fanfare than they did in person.

We are now just beginning to witness what could become known as the “office apocalypse.” Already, offices in Manhattan are experiencing their highest vacancy rate on record, with 19% of office space unused, The New York Times reported in July. Office vacancy rates in cities like Los Angeles and Chicago are even higher. Undoubtedly, people will still work from offices, just as they still sometimes go to malls to shop, but not to the extent they did before. Consumer habits have changed forever, and there will be no reversion to the pre-COVID status quo

The very same behemoth institutions which held onto retail real estate assets will do what they did before, but this time with commercial office space. They will underreport the extent of the shift and attribute their lack of tenants to a need for redevelopment rather than a fundamental problem. Investment committees will sign off on deals. Acquisitions will be made. Pension funds and their brethren will pour billions into the office sector. It may take another ten years for the effects to play out, but the “office apocalypse” is well underway. n