Office Outlook ‘Opaque’

Reonomy, New York, said the office sector has avoided the worst of the recession, largely due to underlying characteristics including tenant diversification and longer-term leases. But it called the sector’s outlook “opaque.”

“The property type may experience a significant demand shock in the coming periods and valuation headwinds if the recovery is not full and soon,” Reonomy said in its Workplace Worries: An Opaque Office Outlook report. “Demand for office space is likely to decline given economic hardships faced by corporate tenants and due to the adoption rate of more permanent remote or distributed employee base.”

Reonomy said publicly traded office real estate investment trusts have lost nearly a quarter of their value year-to-date. While a smaller drop than retail and hospitality REITs saw, there is a growing gap between office REITs and the broader market captured in the S&P 500.

“After the initial shock in the first quarter, rent collections across office properties held up much better than those across retail and hospitality,” the report said. “But transaction activity remained muted and spreads on the debt side remained elevated. Many office property tenants were initially forced to adopt a remote work policy, but as they learned to conduct business with a distributed workforce, management teams began reassessing the necessity of their office space.”

The report said any analysis that calls offices outdated or a thing of the past is overblown. “Companies will continue to find reason to have their employee base centrally located, however it might not be the entire employee base,” Reonomy said.

With decreased demand, office tenants are likely to gain more power in rent negotiations, the report said. “Lease terms may become more flexible, short-term and accommodating to tenants. Capital sources for office investment will likely focus more on tenant risk and rollover risk, and will haircut ‘market’ operating metrics for conservatism,” Reonomy predicted.

The pricing and valuation of office properties will likely see greater variance within each market and the largest metros could lose some of the premium they have historically received compared to smaller markets. “The low prices in major metros may be an opportunity for institutional investors to make opportunistic acquisitions and lead to greater consolidation,” the report said.