Work-From-Home to Pressure Office REITs in Longer Term

Stephen Boyd of Fitch Ratings examines shifting demand factors and what they mean for NOI.
Stephen Boyd, Director of U.S. REITs, Fitch Ratings

The COVID-19 pandemic has demonstrated that working from home is commercially viable for employers and desirable for a large portion of employees. The resulting, large-scale secular shift in working practices could ultimately pressure even the most resilient properties and the REITs that own them.

After the pandemic, many companies are expected to transition to a hybrid model, with varied levels of employees in an office for some portion of the week and some permanent level of working from home for the remainder.

In the short term, changes in prime tenant demand for square footage will likely be slow and incremental, as companies determine the degree of likely long-term adoption, establish more formal, agile working policies, and then determine their long-term space needs. Shorter-term leases and marginal space reductions will dominate leasing activity, which could pressure values and the viability of financing.

According to the January 2021 CBRE Occupier Sentiment Survey, 60 percent of respondents indicated they are aggressively pursuing efforts to reduce space throughout 2020, given low occupancy, whereas 70 percent stated they paused expansion plans, given uncertain space requirements. Both results indicate a strong commitment, or at least intention, by occupiers to reexamine their space needs.

What About office rents?

The likelihood for greater flexible-work arrangements will weaken fundamentals for the foreseeable future. Rents are expected to remain under pressure as REITs focus on rebuilding lost occupancy from vacancy incurred in 2020 and rising subleased space weighs on rent levels.

In the longer term, there may be a greater impact, as tenants reexamine multiyear space requirements, while implementation of flexible, nondedicated office space would further decrease demand.

Tenants are expected to assess their space needs based upon revised density layouts, with more space per employee, driven by marginally increased social distancing and future-proofing against a potential new pandemic. While lowering density would be a meaningful positive trend for office space demand, it will be offset by fewer employees working in the office, resulting in a more neutral overall impact.

For REITs, work-from-home trends present longer-term challenges that may or may not materialize. While much of the country remains under stay-at-home orders, the future of in-office work remains hazy.  As we emerge from the pandemic, and the economy stabilizes, the clouds will finally lift and rebuilding can begin.

Stephen Boyd, CFA, is a senior director in Fitch Ratings’ Corporates Group.