The Big City and its Office Culture is still where productivity thrives - despite WFH

As the COVID-19 crisis grinds its gruesome way from one scary scenario to the next, the one burning and unanswered question occupying real estate minds concerns the future of commercial offices.

While the extent and depth of the damage wrought from our various responses to the virus cannot yet be fathomed, some clear patterns are emerging. The residential bulls are sitting pretty, the logistics investors know they’re on the right side of history, the owners of shopping malls and high street stores have had some time to start licking their wounds, while those who backed hotels are still reeling from the sheer brutality and suddenness of their downfall.

The big question remains – what will happen to the office sector, the asset class in Germany that attracts the lion’s share of institutional investment? Who will benefit from the tectonic shifts that are already realigning our collective use of the vast acres of space in glass and concrete buildings designed to house and harvest the productivity of all those millions of our worker bees? How much of a revolution is really taking place with the new freedom – or in many instances, compulsion – to work from home (WFH), and how will this affect the economics of commercial office real estate, both existing and yet-to-be-built?

Questions, questions, to which none of us yet really have the answers. We’re not yet at the point where the industry acknowledges widescale write-downs in the valuations of their prized office holdings. In the US, the rising delinquency rate for CMBS loans has been reversed in the past two months only because many CMBS lenders have been offering forbearance to struggling borrowers over the downturn, changing their status to ‘current’ from ‘delinquent’ even if the borrower is still unable to pay on time.

A better picture emerges by following the special servicers, who help bail out borrowers when they need loan relief. And their special servicing rate has been jumping each month during the virus pandemic. It is highly likely that the German banks, who still provide much of the lending for European office investment, are looking at similar metrics in their own loan books. While we are likely to hear about it a bit sooner than after the 2008 financial crisis, culturally the German banks are raised to put a more positive gloss on souring loans than their US counterparts, so on the surface all is likely to remain “Unter Kontrolle” for a good

while yet.

In one respect, certain things have changed irrevocably, including greater flexibility to NOT always have to come into the office. Hubertus Heil, the German Labour Minister, has just this week introduced a draft bill giving every fulltime employee in Germany the legal right to work from home or elsewhere for a minimum of 24 days per year, or 2 days per month. Among other benefits, this would give both parents in a working couple the chance for one parenttobeathomeatleastonedaya week. Once this bill goes through – and it’s likely just the thin end of the wedge – it’s easy to see how the whole WFH thing is likely to put down deep roots.

This will bring with it structural changes in the office investment market. After this recession, it’s not at all clear that there will be anything like a return to the patterns of earlier property cycles. Working from home WILL become widespread, we believe, but is highly unlikely to spell the demise of the office, for many reasons.

The effects on the German office investment market will vary from city to city. Frankfurt am Main, which has suffered high vacancy rates for many of the last fifteen years but had been moving back to full-ish occupancy, is likely to see a reversal of its latest trend, whereas Berlin has had practically no available office space for a couple of years now, and is likely to find its existing and new space still much in demand. Not necessarily for the same kind of use as before – usage will change, as will space needs imposed by social distancing, although the lucky Germans are still likely to top the European list in the amount of space afforded to each employee. (Germany never fully bought into the Anglo-Saxon concept of tiny cubicles in a big open room with heads popping up like prairie dogs when you wanted to see what was going on - and we don’t imagine they’re going to start now.)

The Big City, and its myriad offices, is of course more than just a collection of well-educated people and its offices more than just a way to co-ordinate them. Despite the utopian dream of all our finest workers toiling away from their rural idylls, the reality is that cities raise productivity, workers learn and earn more in cities, and for most people to get on in the world, they need to work in close physical proximity with each other, for most of the time.

There are studies that show that the doubling of a city’s size raises productivity per head by between 3% and 8%, depending on the country. Two economists, Jorge de la Roca and Diego Puca, have even tracked people who moved between large and small cities, and showed that half of their gain in productivity came just from working in a bigger city. Fortunately, they even get to keep much of these gains, even if they move back later to a smaller place.

For younger people, open to learning and innovation, the city is the place to be, and to fully avail of the rich offering of art, music, food and all forms of culture, office work in the city is likely to still be the path of choice. The city office is by no means dead. But most of us are also planning to kit out that well-equipped home office as well.

The great re-invention of big company offices has just begun. Along, of course, with the great re-assessment of what they’re all now worth.