Correlation vs Causation
Three US-based economists won this year’s Nobel Prize for their work on real-world experiments that challenged received ideas. The economists used “natural experiments” to come up with observations which hard data might have proved implausible. This has many implications for us in the real estate industry, for example fewer people using offices doesn’t mean offices are obsolete or a reduction in space is necessary. Correlation does not imply causation.
Simple or not, the very real-world question of what employees require to tempt them back to their desks is puzzling future office designers. The vice president of research and global insights for office furniture maker Herman Miller conducted in-depth interviews and roundtable discussions with leaders from hundreds of companies last year to find out. Referring to the quantitative research methods that typically kick off the design process “It’s not a time for surveys… things were just changing too rapidly. Surveys are a snapshot in time, so they’re very helpful if done longitudinally, but not very good as one-offs unless whatever you’re measuring is fairly static. That wasn’t the case, so it was time to dig deeper.” Their conclusion is a so-called “neighbourhood” approach that creates a dedicated space for people in the same department to collaborate, grab coffee or work alone if they choose. The benefit to companies of having workers in the office rather than on zoom is to strengthen the ties to people who are not in their immediate work group, the so-called ‘weak ties’.
The offices of the future will have to compete with other places where people can work. In Manhattan there is a stark divergence in the fortunes between towers that are appropriately configured and those that are not. The most sought-after buildings, like the newly opened One Vanderbilt or Google’s newly renovated $2.1bn St John’s Terminal, are attracting tenants and fetching top rents. In contrast 850 Third Avenue, a glass-and-steel edifice that opened its doors in 1960, is almost half vacant and its owner is struggling to avoid foreclosure.
Another indicator of how fortunes can change is the of One World Trade Center - the 1,776-foot office building that rose in place of the Twin Towers destroyed on Sept. 11 - cost $3.8 billion and is the most expensive skyscraper ever built in the U.S. The entire World Trade Center complex hasn’t made a profit since One World Trade opened seven years ago, according to the building’s owner, the Port Authority of New York and New Jersey. The Center seems to have borne the full weight of tenant reluctance to locate in the same location as the 9/11 attacks with nearby offices seemingly unaffected and performing well. But attitudes toward working at the World Trade Center are now changing due to a generational shift in the workplace. Many workers today were so young on Sept. 11, 2001, they may see it as a distant historical event and not a constraint to working there.?
PIMCO expect that the revised office layouts, designed to lure workers back to the office, will lower occupational densities for prime core office space. This is expected to contrast with a strategy of cutting costs on other offices by moving to higher-density open-plan offices that are common in crowded cities like New York, Singapore, and London. These open-floor-plan layouts can shrink needed space by about 20%. PIMCO offer some solace by pointing out that, unlike Americans and to some extent Asians, Europeans do not relocate as often, and tend to stay in the city in which they grew up. This provides a floor under the market and a certain level of stability and recurring income, despite the space give-back. The increasing importance of quality space will place landlords’ capital expenditures under stronger pressure than ever, especially in the United Kingdom and Ireland. Patrizia also highlighted the differentiation between landlord and poorer quality tenant controlled space: “In London, in particular, there is a great deal of tenant space that is going to produce a polarised market going forward” an asset manager for Patrizia noted.
Investors it seems are keeping faith in the office, with 50% of investors surveyed believing that demand for physical office space will fall by a maximum of 10% over the next three years. In fact, offices are still a preferred asset type for European-based investors, particularly those based in France and Germany, according to INREV. What’s more, 84% of institutional investors and 78% of fund managers plan to invest in offices within the next two years, according to the Investment Intentions Survey of ANREV, the Asian equivalent of INREV.
According to the Bayes CRE Lending Survey, lenders are also keeping faith with office lending margins not moving substantially higher post pandemic, indeed they have contracted slightly for secondary offices. The issue for lenders it seems is not their appetite for lending to offices but office investors’ appetite for borrowing. One head of real estate for a major UK bank told us last week that after the restructuring and waivers negotiated in 2020, many loans have been repaid but they have been unable to recycle it into new loans, which is supported by data in the Bayes Lending Survey which referenced a decline of 6.3% of refinancing of lenders own loans. Indeed, in another meeting with a large debt fund in the same week, they told us that their clients don’t want to take additional leverage, even if it is accretive to project returns.
There is clearly a dissonance between empirical data and observable outcomes, between offices in the same location and their attractiveness to tenants. What is clear is that the data – both ours and the Bayes report – as well as anecdotal evidence, supports the fact that lenders have been very good in discriminating between the two since the pandemic began.