How to Adapt to the Changing Landscape of Remote Work
Remote work is changing our our cities in unexpected ways.
The amount of office workers in major US downtowns, particularly in legacy cities like New York, San Francisco, Chicago, and Boston is woefully low and still nowhere near pre-Covid occupancy. Unsurprisingly demand for office space by large occupiers recently hit multi-decade lows. What does this mean for commercial real estate investment? Where are we seeing opportunities today? Read on to learn more.
Physical Considerations
Distress has come to the commercial real estate markets.
We see it in Pugh Investment’s market in Tampa: the Urban Centre, a ~550,000 SF “premier” Westshore submarket, Class-A office complex recently traded for $123 million or $225/SF. You couldn’t build it for less than $350-400/SF.
Similarly, in Boston, downtown office buildings are trading below purchase prices. Rhino Capital recently acquired 110 Canal St., a 63,000 SF office building for $14.6 million, or $231/SF, just two years after the sellers purchased it for $24 million. For those of you who are counting that is a 60% discount.
Image of Midtown Tampa, owned by Bromley Companies
According to a recent McKinsey report, by 2030, demand for office space is anticipated to be as much as 30% lower.
At the end of Q4 2023, Kastle Badge Swipe Back to Work Index for Major U.S. metro areas is off by as much as 45%+. (See Figure 1 for the most recent data from Kastle Badge Swipes.)
Figure 1: Q4 2023 - Kastle Badge Swipe Back to Work Index
Remote and hybrid work has transformed our daily routines, our spaces, and our relationships.
New York and San Francisco have lost 5% and 7% of their urban core population from 2020 to 2022. In real estate this has implications for everything from downtown office and retail space to suburban development.
As the urban cores are reimagined the suburbs are gaining. Real Estate Developers We are seeing an increase in interest in suburban live-work and& play destinations that are either in the inner ring suburbs or out in the exurbs.
U.S. cities have begun a transformation toward a more distributed, high density, "multi-nodal" network with multiple locations of activity as opposed to the traditional "medieval" singularly- focused urban core. Examples include the Midtown Union in the Arts District of Atlanta, Midtown Tampa in the Westshore submarket of Tampa, even lifestyle centers like Dedham Legacy Place in the Boston suburbs are major hubs of “urban” activity.
Midtown Union - Atlanta, GA
This model reflects Walter Christaller's Central Place Theory with a distributed network. Figure 2 illustrates his theory as a hierarchical series of fragmented nodes punctuated by high density clusters of people and activities. (See Figure 2. Diagram Walter Christaller's Central Place Theory of Urban Form)
Figure 2: Central Place Theorem diagram by Walter Christaller
As Remote Work has become embedded in our society the traditional model of a high density downtown has fragmented and will continue to expand as driverless vehicles and mass-transportation proliferate. This has implications for how we all work, live, and play. It also implies new models for real estate investments are necessary.
Because of this shifting pattern of urban development my partners and I actively look for opportunities to build high-density housing and mixed-use centers in strategically- located suburban locations.
This was previously considered a higher-risk proposition as opposed to singularly focusing on downtown development opportunities.
When it comes to development, many times, suburban municipalities are more willing to work collaboratively because they want the investment. Depending on the city, some have better leadership that proactively seeks solutions for today’s challenges for housing availability and tax dollars. This type of partnership mentality can lead to better outcomes for both investors and for cities.
Key Takeaway: The urban form of the city is changing to a multi-nodal network from a single, dense urban downtown. This has serious implications for economic values and the future of downtowns. But the evolution of economic activity away from downtown cores does not need to be a negative. Opportunities for investments in high-density nodes distributed across the inner and outer suburbs have become financially attractive alternatives.
Social Impacts
According to a recent Barron's article, major companies in the U.S. such as Starbucks and Microsoft have reached a compromise with their employees calling for them to be in the office 3-4 days per week.
As our models of work have changed so has how we relate with our peers and colleagues. Gone are the days where virtual calls are a foreign thing and we only do in-person meetings. This has changed fundamentally how we relate to each other..
When you agree to meet with someone in-person, you are saying to them, "I value you".
A big challenge for younger employees and the upwardly mobile is the challenge of building relationships with mentors and those in senior roles.
The less time one spends in the office around their management and executive teams, the less time they have to connect with them and to learn from them.
“I worry that we’re going to look back in 10 years and the U.S. would have lost a sense of competitiveness because a lot of these people coming into the workforce are getting a fraction of the tutoring and coaching and experiences and intuition that they would have had,” Ric Elias of Red Ventures recently said, “and 30 [or] 40 years from now, we would have lost a lot of our edge because we stopped investing in the people and their creativity and their skill.”
Similarly, going out socially after work has been a staple of building relationships. With this occurring less and less, young professionals have less time to grow those relationships and can miss small, but important learning opportunities about business nuances they can learn through casual conversations.
Proactive companies are growing their mentor and social programs to connect like minded individuals with those that want to grow their careers. If you are looking to expand your network and learn from more senior people I recommend you reach out and get to know what might be available in your community.
For example, Pugh Management actively engages with the community through mentorship programs with local universities. In 2023, I presented to the University of Tampa Real Estate Club and have an ongoing engagement with their students. This past year we hired a summer intern from the program and plan to continue this in the future.
Key Takeaway: As our environment changes so do our personal and professional relationships. Look for ways to connect with your peers and more senior executives in person. You’ll quickly see the value both personally and professionally.
Economic and Zoning Changes
Downtown Tampa, FL
Commercial real estate's contribution to the U.S. GDP is approximately 5% or $1.2 trillion,according to Canyon Data.
Remote work combined with higher interest rates over the past 18 months has impacted the value of downtown office buildings and commercial real estate values in general by as much as $506 Billion according to a recent EY report.
Within the past 6 months, the impacts on office values become abundantly clear as downtown buildings have begun to trade at 30-60% (or more) discounts to their purchase prices.
Some institutional owners, such as Boston Properties, continue to question how significant the impacts of Remote Work are on office property values.
“Though Remote Work is not helping space demand we believe economic conditions are the primary driver of slower leasing activity in 2023 and leasing will rebound when earnings growth returns…
We believe the broadly reported turnstile data by Kastle Systems is relevant to planning for cities but is not relevant for office space users for premier office space users.” - Boston Properties (BXP) CEO Owen D. Thomas on the Q3 2023 earnings call
Given this quote, there is a variety of experiences of office owners and occupiers in our cities.
An article by Brad Hargreaves on Thesis Driven blog provides the following options for the future of downtown office buildings:
Flexible Office or CoWorking Spaces
Residential Conversion
Industrial and Logistics
Community, Recreation, Education
Cheaper Office Space
These options capture the complexity of the problem and implies there is no one clear solution.
In terms of the impacts on cities, it is yet to be fully seen what will happen to the municipal tax base, the reduction in sales taxes for retail, and the economic losses because of less people living and working downtown. We can only work towards and hope for a positive outcome for our great cities. To drive the change and create favorable outcomes, we will need to come up with creative solutions for these spaces.
Not only will we, as real estate professionals need to repurpose buildings into affordable housing or new versions of office space, we will also need to champion changes to municipal zoning policies to allow for a mix of more types of uses, including residential in formerly office/commercial only areas.
In 2023, cities like Boston and New York implemented changes to their zoning and approvals processes to assist in the creation of affordable housing and to expedite new uses.
The industry will need leadership and flexibility from municipalities and private developers alike to facilitate changes to our zoning. We desperately need these zoning updates for our cities to modernize and advance economically, socially, and physically.
Hopefully these actions will shape the future of our cities so we can remain competitive and continue to attract the best and brightest.
Potential Investment and Development Opportunities
The great thing is that changes to our cities from remote work are creating a multitude of new types of investment opportunities for developers and investors. There are some investors better positioned to act and to take risks during this time of disruption. Those with fortress balance sheets are going to be able to strategically identify investments and close on them with cash or private debt.
“In the coming quarters given the negative sentiment towards the office industry …, we believe BXP will be presented with unique opportunities to expand its portfolio on an attractive basis…
In anticipation of the current market distress in the office sector we have been positioning BXP to play offense.” - - Boston Properties (BXP) CEO Owen D. Thomas on the Q3 2023 earnings call
Regional and National Banks have continued to lend selectively during the rise in interest rates over the past 18 months. Though they are almost completely out of the ground-up market for commercial and multifamily in urban areas.
Owners with deep pools of equity may want or need to reimagine their properties to reinvigorate assets with new tenants and cash flows. Some portion of owners portfolios can serve as test cases for big ideas, like repositioning office to multifamily.
Though given the lack of clarity many institutional owners will look to solidify their balance sheets and wait for the smoke to clear.
At Pugh Management, we continue to look for strategic investment opportunities in this challenging macro-economic environment. We recommend those entering the market to be highly selective and maintain a high cash balance, so you can act as distress continues to emerge.
Distress will be different across geographies and product types. During a recent call with a capital markets representative from JLL, he noted the lack of distress in Boston multifamily.
He indicated this is due to the heavy supply and demand imbalance and strong wage growth in the city.
Elsewhere overbuilding of multifamily has created distress and buyers are beginning to pick up high value investments. This is illustrated by Grant Cardone’s recent purchase of a Tampa Bay area multifamily asset for $39.24 million from the seller who had purchased the property in 2021 for $69.65 million.
Today repositioning and redevelopment of these downtown assets is particularly challenged as it is not clear what programmatic strategies will and will not work. This lack of financial clarity creates a high amount of risk for owners and investors in the downtown space. But what is clear is that some owners and buyers in 2024 will have to take a proactive approach to get their properties cash flowing or they may lose them to foreclosures and bankruptcy.
Key Takeaways: Consider creative redevelopment strategies to stabilize assets. If you have deep pools of liquidity, position yourself to take advantage of discounted properties in 2024-2025.
