Where Will I Go? What Will I Do?

The title of this month’s post, Where Will I Go? What Will I Do?, is an often-quoted line by Scarlett O’Hara from the movie “Gone with the Wind” (one of my all-time favorites). It may also be a question on many employees’ minds as the work environment transitions back to “normal.” The answer may have some profound consequences for commercial real estate owners and developers – and, by extension, their financing sources – involved in leased office space.

The business response to the recent pandemic demonstrated that a considerable amount of work that used to be done in the office can be done remotely. Now, as restrictions are relaxed, will employees return to the office, and will they have a choice? Jamie Dimon, CEO of JPMorgan Chase, recently issued a directive to all employees to report their vaccination status by June 30 and return to the office by July 6. Dimon is quoted in a June 25, 2021 article for “Moneyist” saying that working remotely “…doesn’t work for people who want to hustle, doesn’t work for culture, and doesn’t work for idea generation.” James Gorman, CEO of Morgan Stanley, had a similar response, saying that “…if you can go into a restaurant in New York City, you can come into the office.”

Where Will I Go? What Will I Do?

Employees quickly adapted to the freedom and flexibility afforded by working from home, including eliminating long commutes and finding a better balance with work vs. home life responsibilities. Chris Herd, founder and CEO of Firstbase, a company that helps other companies transition to more remote work environments, acknowledges that the transition to remote work environments can be one of trust.

He also questions how many “lightbulb moments” really occur around the watercooler or offices which he terms “instantaneous gratification distraction factories.” He also noted that by allowing people to work from home, a company can recruit talent from geographies with lower employee costs, thereby saving the company money. James Gorman (Morgan Stanley) might agree, but with the caveat for those living in large metro areas that “…if you want to get paid New York rates, work in New York.”

While employees may have adapted quickly to the new-found flexibility, working from home during the pandemic also revealed its limitations, particularly in knowledge-based organization/industries where success still depends on face-to-face interaction, collaboration, and training of new or younger employees. Some organizations find that use of online video conferencing slow down decision making. There was little immediate follow-up compared to in-person meetings.

What Will Happen to the Office?

What does all of this mean in the office space sector of investment real estate? We do know, according to recent analysis by Marcus & Millichap (a top real estate investment brokerage company in North America), office vacancies are up 310% from pre-pandemic levels to 16%. We also know that working remotely works differently for different industries. However, many experts agree that the trend toward remote working will inevitably result in an overall reduction in occupier demand. Will demand revive? According to Marcus & Millichap, if only 10% of companies go “full remote,” vacancies will continue to rise. Office space in the urban core is likely to see an exodus (risk) in favor of local suburbs or even different cities (opportunity) depending on the success of remote working. To the extent that employee desire for remote working alternatives can drive employer behavior, some type of hybrid model of office/remote is likely.

The type of space is also likely to change. Tenants will be looking for more modern, flexible space, which will negatively impact older buildings. The “office” will need to be a destination with a purpose, not just a place to go. For some employer/tenants, space configuration may be to more of a “hoteling” model. This is in an attempt to get to a ratio of less than one desk per one person. Others may value more space on a per-person basis for social distancing reasons. This will create a better team environment, or enhance collaborative space. In the near term, tenants are likely to be looking to reduce lease terms at renewal as they continue to evaluate remote versus in-person work environment productivity and efficiencies.

How Will It Affect Financial Institutions?

This “sorting out” will certainly be a multi-year process. Financing institutions must not neglect the impact the ultimate decisions will have on related real estate sector demands. This is including housing, retail, industrial, and self-storage.

As credit professionals, what should we be doing? There is probably no time like the present to begin looking at your institution’s CRE office-space portfolio. What is the tenor of lease expirations? What type of tenant occupies the space? Is the tenant in an industry that would lend itself to a remote working model? How has the pandemic impacted the individual tenants? Would shorter lease renewals impact the tenor/maturity of the existing and future financing? How will declining lease rates impact real estate values? Perhaps this is a project where an outside professional team such as Enlighten Financial could provide assistance.

On the other hand, one could follow the example set by Scarlett O’Hara. When you’re thinking about Where Will I Go? What Will I Do?: “I’ll think about that tomorrow.”

Richard Rudolph is Senior Consultant at Enlighten Financial, a specialized consulting firm that focuses on loan review and risk management services to community banks and credit unions. Enlighten Financial has made it our business to shed light on the complex financial landscape. We lead clients in the right direction. We work with financial institutions and other providers to mitigate risk. To talk to Rick directly, please call: 920.445.8133.