The commercial office real estate doom loop that was expected from the growth in remote working hasn’t really caught on, according to Victor Couture, assistant professor of economics at the University of British Columbia’s Vancouver School of Economics, speaking during the Canadian Investment Review‘s 2023 Global Investment Conference.
Remote work is almost certainly here to stay, which is why the real estate market is under much more stress post-coronavirus pandemic. “Remote work means . . . reduced foot traffic for downtown retail [and] fewer residents who need to live close to work,” he said. “So residents are . . . leaving, retail is leaving and each time someone leaves that makes that whole area less attractive. Then you can get . . . a bad equilibrium — a kind of doom loop.”
Vacancy rates are slowly rising, he noted. “They’re higher than they were after the [2008/09 financial crisis]. So why the slow rise? Because these buildings . . . have long leases.”
The average office lease is seven years, with many already expiring by the start of the pandemic, said Couture, noting that, as more leases expire, companies are renewing them at a lower rate.
In the U.S., remote working has seen a rapid drop off after government shutdowns ended in 2021, stabilizing to around 25 per cent of the workweek. In Canada, he said, the share could be even higher, up to 40 per cent. Indeed, since January 2022, the share of employees that are fully remote has declined. For most organizations that have moved to a hybrid work schedule, two days at home a week — usually Mondays and Fridays — is the norm, he added.
In addition, propensity for remote working varies across cities and sectors, so the pain in the commercial office real estate market isn’t evenly spread. For instance, large technology firms, finance and insurance and professional business services are more likely to have employees who work remotely — and they typically rented top-notch, class A office buildings.
Despite the uncertainty, the real estate market is showing some resiliency, said Couture, noting there’s been a marked flight to quality. “The very best buildings seem to have . . . higher occupancy levels and the class B . . . building that used to have . . . specialized [information technology] workers . . . are under the most stress [with] lower occupancy.”
Since most of the leases signed pre-pandemic have now expired and remote work trends stabilize (at least on the leasing side), there’s less uncertainty, he noted. Indeed, it’s now possible to relatively value these buildings going forward. Although regional banks, which tend to issue real estate loans, have been under stress and investors are navigating a period of higher mortgage rates, they’re still seeing commercial real estate loans renewing over the next quarter.
“There’s a significant impact on balance sheets, but that, again, can be computed. . . . You can compute how [real estate investment trusts] will be affected by rates [based on] what rates are today and when these mortgages renew.”
While Couture is cautiously bullish about the prospects for the core office space market, he admitted there’s still some risk in this area, but he doesn’t believe the market is drying up. “They’re still very attractive for a lot of people, especially younger professional people. Hybrid work involves some time in the office. Face-to-face interactions are necessary for innovation, for knowledge transfers, for mentoring, for economic growth and for building trust within teams.”
Employers want employees back in the office and, as the labour market gets tighter, they might actually succeed in bringing them back, he said.
While the current market value for commercial office space includes a lot of fear and uncertainty, analysts with market knowledge will find the opportunities, he continued, noting class A-plus buildings are still highly desirable, fully rented and are probably undervalued right now.
Read more coverage of the 2023 Global Investment Conference.