Capital Insights: August 2023

From Buchanan Street Partners President & CEO Tim Ballard

Will Work from Home Kill the Office Building?

Since the start of the pandemic, corporate America rapidly evolved to the work from home model aided by technologies such as Zoom and Microsoft Teams. What started out as a government mandated necessity has now evolved into a bright contrast of different corporate strategies, some embracing work from home models and others recognizing the many pitfalls of working remotely. Furthermore, tight labor markets have provided employees with the power to determine how they want to work, many electing to work from home.

Kastle Systems, the maker of keycard entry systems, tracks the percentage of employees that go to work. On average about 50% of workers go to the office today but this varies widely by region, with 37% going to the office in San Jose and over 60% in Austin. As tenants’ leases mature, many tenants are choosing to downsize and work in less space because of this. Currently, office vacancy rates, depending on the market, generally range from 15-20% but when you combine that with the fact that 50% of those tenants’ employees are working from home, current office usage is at historic lows.

While there are some benefits of the work from home model, including removing the commute and increasing employee’s flexibility to deal with life’s demands, there are many negatives. These include the lack of social interaction, difficulty in onboarding new employees, creative brainstorming ability and building culture and relationships. Many CEOs have recognized the need for in person work and have issued mandates that employees return to the office on a full-time basis, including JP Morgan, Tesla and Twitter with many others demanding at least partial office attendance. Ken Griffin of Citadel credits their massive outperformance in 2022 due to the fact that they never adopted a work from home model.

Despite the many benefits of going to the workplace, we believe that there are some companies that have employees that execute solitary jobs that can be done effectively on a remote basis. When combined with a high percentage of employees that want to work from home, this will have a long-term negative impact on overall office building demand and values.

This impact is playing out in different ways. CEOs who want employees in the office are utilizing various tools to incent the behavior, from outright attendance requirements to seeking highly amenitized office space where employees desire to come to work. This has resulted in very little demand for commodity-type office space (think of a 10-story class B office building built in 1985) but continuing strong demand for the very best buildings, whether they be creative office or AA office with every amenity that you can imagine. We don’t see this trend reversing anytime soon.

In Orange County, a high-quality office asset owned by an institutional investor recently traded for $115 psf, reflecting at least a 55% loss from its 2019 purchase price of $255 psf. This is due to several factors that include lack of tenant demand, unwillingness of lenders to make office loans and overall lack of interest from office building investors. Most owners would be unwilling to accept this sale as they owe more than the building is worth. Lenders will ultimately need to be part of the decision process as assets continue to struggle.

We believe that the most likely answer is that many office buildings will be demolished and turned into other asset types due to their desirable locations. A limited few will have adaptive reuse potential, such as medical office and life science uses. Some developers have entertained converting office into residential but the large floor plates, inadequate utilities and lack of operable windows make it difficult to convert most existing office buildings.

At Buchanan we believe that office building owners will likely suffer for the foreseeable future, but a few will do well. The ones that will benefit are those with the very best assets and those with the skill to figure out what an asset should become and how to execute that vision.