While the Commercial Real Estate sector spans multifamily, industrial, retail, and office properties, the office segment has received the most airtime recently as investors wonder how hybrid and remote work, along with higher interest rates, will impact the future of the space.
As the following chart demonstrates, the office segment has indeed suffered a steeper decline in occupancy rates than the rest of the sector.
Chart 1: Decline in U.S. Occupancy Rates More Pronounced for Office vs. Other Properties
Source: Goldman Sachs, June 2023
Outlook for the Office Segment
What factors will drive office space occupancy going forward? Consensus amongst Commercial Real Estate researchers seems to be that office utilization (based on security badge swipe data) will stabilize at 50 – 60% of pre-pandemic levels as employees settle into a schedule of working remotely 2 – 3 days per week. As Chart 2 projects, office occupancy may bottom out at 81% (19% vacancy) in 2023 and then recover slowly as new office inventory declines and office-using employment grows. The previous highs of 90% occupancy could be a relic of the past.
Chart 2: Office Vacancy Rates and Economic Drivers
Source: Moody’s Analytics CRE, February 2023
Because many businesses now view their office space as the center of a dynamic employee experience, they are more focused on finding high quality buildings with spaces designed for collaborating and socializing. As a result, these types of buildings are holding their value better than their competitors. Increasingly, it seems that older office buildings without amenities or (increasingly popular) sustainability credentials will be the ones to suffer the most.
What Does it Mean for Verger and our Clients?
The Commercial Real Estate sector is quite large. In fact, it’s the third largest asset class behind equities and fixed income. Office properties account for less than a third of the sector. Many other interesting areas exist within the sector beyond offices – including warehouse and logistics facilities, or as we pointed out in our first quarter market commentary, self-storage.
At Verger, our investment process features unconstrained idea generation and a nuanced approach to asset allocation. We find creative ways to make allocations based on risk and return exposure, not asset class labels or benchmark breakdowns.
Some of our Commercial Real Estate managers continue to find investment opportunities in office properties within certain geographies or sub-markets with limited supply. Other managers may choose to avoid the segment completely. Now, as ever, we remain committed to positioning our portfolio to opportunistically take advantage of market dislocations as the sector evolves.
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