Professor Glenn A. Okun
Hybrid work arrangements have become the generally accepted compromise for businesses. While it is not as common as it had been during the pandemic, it remains a prominent solution. The resulting reduction in office space needs will diminish the value of office real estate and will exacerbate the commercial mortgage default rate in the near and intermediate term.
Surveys of CEOs and CFOs have made it clear that businesses have reconciled themselves to hybrid work as the inevitable compromise between employers who would desire a full return to the office and employees who would prefer remote work. The Conference Board reported that under four percent of chief executives polled will prioritize a full time return to the office this year. A Deloitte survey of CFOs indicated that sixty five percent expect to offer a hybrid work option in 2024. Goldman Sachs recently estimated that twenty five percent of U.S. workers have part time in-office arrangements.
While the current twenty five percent level of hybrid work is well below the pandemic peak of forty seven percent, it is far in excess of the three percent usage prior to Covid. It represents an acceptance by employers of the approach when there is no compelling justification for full time in-office work requirements.
This trend benefits both parties. As a result, its growth is assured. Employers that can monitor remote work productivity and quality will realize substantial savings. The most significant cost reduction will be in real estate lease expenses. This savings could greatly exceed a space reduction proportionate to the hybrid worker headcount by eliminating designated enclosed offices. Open office format shared space used on an as needed basis becomes the acceptable norm for employees that spend more time at home than on site. The Rabid Capitalist projects that hybrid work employers may realize up to a forty percent savings in office space requirements as a result.
This is catastrophic for office building owners and their lenders. Rent roll and cash flow projections will reflect the reality in increased vacancy, lower lease rates, higher unreimbursed building expenses and reduced cash flows. Real estate value and loan credit quality will continue to plummet after a thirty five percent diminution in office values since 2022 (see https://therabidcapitalist.com/2024/01/13/bank-earnings-season-is-commercial-real-estate-loan-write-off-season/).
These effects have been confined largely to lower grade older office properties to date. Unfortunately, trophy office real estate will not be immune to these work trends and the aforementioned financial consequences as hybrid work trends continue to proliferate. The office REITs do not reflect these effects in their valuations.
The Rabid Capitalist views the resurgence in office real estate owner and lender equities, such as Vornado, Boston Properties and the regional banks, as a dead cat bounce. Their valuations reflect an irrational optimism regarding the future of work and the fair market value of office assets. Investors should avoid these stocks since the degree of growth in the hybrid work trend and the resulting damage to office real estate values are indeterminate.
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