WFH & The Flexageddon

WFH will widen the gap between winners & losers in the office investment sector

JLL Market research gurus tell us that on average employees would like to work from the office 2.4 days a week. On the face of it, that’s bad news for office investors. But it’s not automatically – or at least universally – a harbinger of doom. There will be winners and losers. And picking winners requires investors to spend a few moments understanding what’s going on in the minds of both employees and employers – something they didn’t have to do in the world of long leases and quarterly rent collections.

I recently talked to a head of local government about 2.4. “It’s not so simple”, he patiently explained. “One third of my workforce are entirely location-based such as medical staff. Then I have another third who are entirely field based. These are people like carers in the community and they file paperwork electronically, rarely entering the office. Finally, I have a group of administrative staff who would probably like to WFH for some of the week. So, 2.4 for us is really a blend of 0, 5 and 2-3 days.” The first point to acknowledge is that 2.4 is not “a new normal”, it’s a blend of widely differing job requirements.

Moreover, those job requirements change according to the lifecycle of a given area of work. An LA-based entrepreneur who works in the green energy sector recently lamented to me what he sees as a lack of willingness by new team members to embrace the frenetic romance of the start-up. Presentism might be a rude word but sometimes, it seems, you need to be physically together to get sh*t done. A more mature group, on the other hand, that has worked together for years establishing trust and shared values may work effectively as a more dispersed team. Indeed, companies like training provider Global Integration and culture experts Within People have this discipline down to an art form.

Even within teams there are socio-demographic differences. The young tend to like the office because the Covid years starved them of social interaction and they yearn for normality. The old would be lost without it. The poor live in cramped conditions and go to the office as the least bad option. The Class of 2.4 has its spokespeople and they tend to be mortgage-paying, career-worrying, parenting, dog-walking middle managers for whom life is a lot about plate-spinning. And according to him/her/them the new arrangement is a boon to productivity. Perhaps it is - but it’s hard to tell in the context of Covid and myriad other recent black swan events that play havoc with the macros. Common-sense, however, tells us that the brightest and the best of the Class of 2.4 will capitalise on their new-found freedom to excel. The feckless ones at the back of the classroom however…

Employers are now responding to this new choice-making. Goldman Sachs requires its workforce to be fully present at all times. Facebook, by contrast, is happy for its folks to live as avatars in the WFH Metaverse. Others tread a conditional path. When law firm Stephenson Harwood announced that they would permit full-time WFH but cut pay by 20% for those who were no longer having to pay London living costs the bloggers howled in dismay. All this complexity means that CRE professionals have to stop thinking of tenants purely in terms of covenant and visualise them as customers, in different segments and requiring offices for different “user occasions”. As flexible workspace proliferates, occupancy levels and customer stickiness become key, as they do in the hotel business. No longer are investors inoculated from the habits of individual office-dwellers. Inexorably, the industry is moving B2C.

So how should investors prepare for this shift beyond hiring a few more marketing people with non-CRE backgrounds? The key to success for investors is to put their money into products and services that their customers actually want. Psychologically, it is a case of "delight the customer and the profits will follow" rather than focusing on required returns and seeking a tenant who will cooperate. The evidence is that the smart money is already doing so. Recently reported market rents, space uptake and yields for well-located Grade A space support continued strong valuations in many of the World’s major cities. These buildings are often amenity-rich, campus-based or otherwise desirable for the Class of 2.4 wondering whether they can justify the commute to themselves. If they can cycle into work, swipe-access, take a shower, grab a cappuccino and book a meeting room with a user-friendly App they’re more likely to make the effort. Conversely, some research that was conducted by Flex operator Storey suggested that people quickly tire of funky warehouse style offices that – however fashionable - lack robust functionality. Dodgy wi-fi and leaky roofs just aren’t acceptable. Quality is key.

Property giants like Brookfield are amassing brown-to-green investment funds, anticipating something of a winners-takes-all outcome when carbon guzzling buildings drop out of favour or even become downright illegal. NZC is the new battle cry. Globally, sustainability-based funds grew by an eye-watering $3 trillion in H1 2021 alone. At the asset level British Land took a ￡30m punt with the acquisition of 6 Orsman Road, a cross-laminate timber creation of architects Thistleton Waugh in Haggerston, an area that is stretching the corridor of cool that is Spitalfields-Shoreditch. The building is now nicely washing its face with interesting occupiers and TOG/Blackstone are pushing the timber envelope further with the Black & White building in Hackney due to open later this year. These are audacious investments and they will one day be played out on an even grander scale in assets like the biophilia-centric Welcome building being designed by Kengo Kuma in the Lambro park area of Milan. Employers will pay high rents for such buildings because the simple act of occupying them confers commercial advantage. Employer brands are enhanced. Customers are impressed. Shareholders feel their profits are noble.

Flexibility is the third arm of the Quality-Sustainability triptych. 7% of London Grade A office stock is currently classified as flexible workspace. That figure – broadly defined – is anticipated to expand to 30%. This is good news for the likes of new operator love-birds TOG/FORA but it also manifests as more landlords self-serving with Storey, MYO, MadeFor and other brands. The big agencies like CBRE have taken a stake in operators like Industrious while their counterpart JLL prefers to offer a white-label service to investors. Flexible event companies like Convene bravely battled through the Covid maelstrom and have emerged wiser, leaner, tech-enabled and recapitalised. Inevitably, flexibility is heavily supported by technology; employee experience Apps, touchless workplace entry systems, meeting room booking engines – you name it. Valuation experts meanwhile have looked up from their Red Books (RICS) and concluded that, whilst flexible leases reduce cap rates, a strong operating cash performance over time can more than compensate, delivering accretive outcomes to the asset. Flex is no longer a void mitigant, it is a value-added ingredient in asset and leasing strategies.

On the face of it, 2.4 could suggest a shocking halving of office requirements. But workplace experts would point out that offices have always only been c.60% physically utilised so maybe that’s a more modest 12% reduction. It depends on whether Employers smooth office usage effectively across the five days of the week, improve overall utilisation in general and whether Employees really mean 2.4 or intend further handicapping through holidays, sickness, business trips and so forth. Either way, it’s hard to avoid the conclusion that there will be some space redundancy or re-pricing.

Whatever the final figure, six years from now the WAULT (weighted average unexpired lease term) will force the CRE markets of London and elsewhere to face the reality of these trends, unprotected by outmoded lease arrangements. Those that have focused their investments in advance into high quality, sustainable, flexible assets with an eye on customer trends will do very well. But not everyone will live happily ever after. If the 12% space reduction is heavily concentrated in the poorest third of stock, the impact could be dramatic for those who won’t – or can’t – change direction. Assets that are poor quality, brown, rigid, over-priced and in the wrong place are heading for Flexageddon.