Don’t write offices off just yet

Writing loans against office property is currently difficult. But lenders were already pondering the evolution of the sector before covid made things more complicated.

Office scene

The mass working-from-home experiment sparked by covid-19 has led to many newspaper articles posing a somewhat provocative question: is this the end of the office?

The answer, most of these pieces ultimately conclude, is ‘no’. But most in the property industry agree that this prolonged period of remote working, coupled with the conundrum of accommodating social distancing as staff filter back into their traditional workplaces, will have long-term implications for the way we work.

For those who finance real estate for a living, underwriting office property is difficult right now. Anyone writing a five-year loan in the sector faces questions none of us can really answer.

Debt market sources say offices currently lie somewhere in the middle of the spectrum of asset prospects. While retail and hospitality are giving lenders sleepless nights, and logistics remains enticing, offices are a worry, though financing deals in the sector continue to be closed. Break clauses in tenancy agreements are a concern because of the fear that occupiers will take the opportunity to downsize, in the middle of the loan term, while the crisis plays out. Office financing deals with a refurbishment angle are also challenging, given the difficulty in assessing where upcoming rental levels will land.

Although there is plenty of confusion about the prospects for the office sector, a paper published on 17 July by UBS provided some perspective. The Swiss financial services group said that while there will be lasting impacts as we return to some form of normality, they will generally be accelerations of trends already identified. It went on to suggest that claims covid-19 marked the beginning of the end of the office as we know it had been largely overdone.

By UBS’s reckoning, occupiers will pay an increasing premium for flexibility, a trend already much discussed as a result of the rise of co-working and the flexible workspace industry. There will be greater focus still on the quality of offices, it suggested, as businesses prioritise top-class collaborative space over traditional rows of desks. It also highlighted the defensiveness of core, central locations, given the fact that offices may need to be more accessible to staff living further away as they spend more days working from home.

Offices, UBS concluded, will not suffer the same drop in value as retail, partly because the sector is far more adaptable and underpinned by alternative use options such as residential.

These trends have been pondered by real estate debt providers in the last few years. The growth of the co-working concept prompted lenders to consider underwriting flexible, operator-run offices as they would hotels. Similarly, the debate about what makes a top-quality, resilient building has come under scrutiny as environmental, social and governance factors have risen up debt providers’ agenda.

Lenders do not have the answers to all these questions yet, and covid-19 will prompt a wide-ranging debate within the real estate industry about the future of the workplace, which debt providers need to be part of.

None of this is much help to those pondering office financing situations today. But although there is plenty of uncertainty ahead, lenders should not write off the sector just yet.

See sister publication PERE’s deep dive into the issues faced by private real estate investors underwriting office investments here.

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