Office Space Still a Compelling Investment — With Risks

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Larry Antonatos

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Larry Antonatos, managing director and portfolio manager, Brookfield Asset Management.

The Covid-19 lockdowns have highlighted the ability of many office employees to effectively work from home. Now, as reopening progresses, some companies are moving to a more flexible hybrid work structure, including both work-from-home and work-from-office. This has prompted a big question among real estate industry observers. Will work-from-home become an important part of the norm over the long term, leading to a permanent drop in demand for office space?

At Brookfield, we believe the answer is no. In our view, both successful companies and successful employees value the power of in-person collaboration. While remote work can be effective in the short and even the medium term, it cannot replace human interaction in the long term. Our view focuses on the area in which Brookfield focuses our investments, that is top-quality office buildings in major urban centers. We expect these assets will generally fare much better than lower quality office buildings in smaller markets.

Big picture, we anticipate three trends emerging over the longer term. First, working from home will ultimately become a supplement to, rather than a substitute for, the office. While remote work can provide flexibility for employees, office work allows for collaboration, connection and culture, essential ingredients for enterprise growth, risk management and employee development, particularly for newer employees and younger employees.

Second, we anticipate that Covid-19 will likely reverse the office densification trend of the last few decades. With certain social distancing norms and health and safety protocols likely to endure, office square footage per employee will need to increase. This is counter to the historical trend where office square footage per employee has decreased from 425 square feet in 1990 to 225 square foot per employee in 2010 and 150 square foot per employee in 2020.

A third major trend is we expect major cities will continue to serve as magnets for talent. Urbanization has been a powerful trend for centuries for one simple reason, commerce and culture thrive in the vibrancy of a great city.

Viewing office markets through the lenses of market size, market desirability and market adjacency and viewing office property through the lens of quality, we have a few observations and expectations.

On market size, major markets will continue to be important, particularly for global companies, for deal-oriented businesses, such as investment banking or M&A, and for creative industries. For example, we believe Toronto, New York and London will always be important.

From a market desirability perspective, better quality of life due to better weather, better schools, easier commutes or lower taxes may allow smaller, newer markets to attract sufficient jobs and talent that these markets may actually attain the critical mass of larger older markets. In the United States, Austin, Texas and Nashville, Tennessee are success stories in this regard. These markets are prime opportunities for investment.

Considering market adjacency, we expect the most attractive residential suburbs and second home markets convenient to major office markets will see increased demand for satellite offices. Near New York City, for example, Greenwich, Connecticut, and even The Hamptons have seen increasing demand for office space.

In considering property quality within all markets, we believe the highest quality property will get stronger and stronger, and lesser quality property will become less desirable and perhaps will become obsolete.

In summary, Brookfield’s optimistic long term view on Class A office in major markets is perhaps contrarian. We see public real estate companies with outstanding office portfolios in major global cities trading at significant discounts to underlying real estate asset value. This is a compelling investment opportunity, but is not without risk. In the short run, Covid-19 cases may persist, in the medium run, the return of the workforce to the office may be slow, but in the long run, we believe Class A office in major markets is essential to business, is essential to creativity, is essential to employee development and will be resilient.