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Is This the End of Investing in the Office Sector?

How and where workers work and how businesses lease space will all change – but the end is not nigh.

Almost as soon as America’s office workers began hunkering down at home, the questions started being raised: What will happen to commercial real estate? Is there a future for the office sector? What does it all mean? These are all good questions, and they are addressed in a new paper from Aegon Asset Management (Aegon AM). The firm is well-known for its observations and insights on real assets, and II recently spoke with Martha Peyton, Aegon Real Assets' Head of Applied Research, about the current state of the office sector and how it could change.

The newly released paper from Aegon AM concludes that the U.S. office sector is not facing an existential threat. On what do you base that conclusion?

Martha Peyton: It is correct that we don’t see the threat as existential, and we base that on two pieces of analysis. First, this isn’t the sector’s first time down this road. When rapid change and adaptation of technology facilitated more work from home, the office sector encountered the trend known as “hoteling,” where workers don’t have a permanent desk and instead work wherever space is available when they are in the office. Some very big companies adopted work from home and hoteling in some form. Historically, after an initial flurry of enthusiasm and a lot of press about innovation, many companies realized they’d rather have their people in the office, for various reasons. Yahoo was a good example of that.

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What’s the second part of that analysis?

Over the last few months, a number of surveys have been conducted regarding office worker preferences. Despite some variation in the exact percentages, they indicate workers want increased flexibility to work from home, but still desire an office environment at least part time.

When you add up the fact that we’ve been down this road before and that very few people want to work at home every day, there must be something else drawing people to the office. After all, isn’t working from home a big improvement over commuting? Under the current circumstances, doesn’t it greatly reduce the chance of exposure to COVID-19? And now that we’re all sensitized to the COVID contagion, we logically shouldn’t want to work physically close to other people or get in crowded elevators.

So, what do you think that “something else” is?

I think it’s a need to be part of a business or company culture – a combination of wanting to play a role in creating, maintaining, and enforcing that culture. All of that is a product of personal connections and frequent in-person interaction. It’s very hard to keep that going when people are not in the same physical space.

Now, a lot of people right now are saying, “We’re doing great with work at home,” but how do you inculcate business culture in new employees if work from home continues for a long period of time? How do you get those people up to speed and connected to the business culture? I think another part of the “something else” is that human beings are social creatures. Some people don’t have a lot of need for social interaction, but most people do. We saw that vividly when states started to relax operational restrictions on restaurants and bars – younger people rushed out to them because they had a need to be with other people.

What you’re talking about is really key to how individual businesses function, yes?

Yes, and that’s what I mean by business culture – how individual businesses assess information, assign goals, assess their market and competition, and how they enforce how people treat each other as members of a business.

It seems inevitable that office layouts and how we work in them will change. How do you anticipate that will unfold?

I think what we’ll see is a reversal of the office evolution that’s been happening for the past 30 years or so, during which time office space use became denser and denser, with a very noticeable decline in space per employee. Part of that was driven by technology, because modern office workers don’t need a lot of space for filing paperwork, for example. Law firms don’t need space for libraries anymore, as another example, and that space came off the leasing requirements for them. Thirty years ago, offices had many administrative assistants – now one supports entire teams of people. Again, less space was needed. In recent years, cubicles, not to mention closed offices, have given way to the bank space that became common in tech companies. That is probably the minimum space necessary for people to work in an office. Going forward we’ll see de-densification because offices can’t have employees sitting on top of each other. That’s not going to work anymore.

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How do you see that playing out in the near term?

It means bringing back fewer people at a time and keeping some people working at home, and putting more space between them when they are in the office. That de-densification and awareness of contagion will likely drive up the cost of occupancy. There will be demand for improved housekeeping and improved ventilation, and demand to control how many people are in an elevator at any given moment. I think we’ll lose our enthusiasm for the office kitchen and common areas. Another thing we’ll see is an adjustment on the supply side, because that rise in occupancy cost will, of course, diminish the demand for space.

Were we heading in that direction anyway, and the twin crises of pandemic and economic stress just forced the issue?

Before COVID-19 there were surveys that showed office workers were not enamored with tight spaces, and common complaints included: “This is too noisy. I can’t concentrate. I need more space. I need quieter space. I need access to more conference rooms or private spaces where I can close a door and do what I have to do.” We were approaching a turning point. Unexpected things happened and we got there very, very quickly.

You were touching on supply and demand, and that’s really at the heart of it. So, do all of these other changes you’re talking about also change the game?  

To answer that you have to unpack the forces that are affecting demand and supply. In the paper, we distinguish between the cyclical forces and structural forces that are currently pulling in opposite directions. We are in the midst of a very serious recession. To illustrate that, in the great financial crisis that began in 2008, real GDP declined 2.5% in 2009.1 In the current crisis, the Blue Chip survey of forecasters is, as of July 10, expecting a 5.5% decline in real GDP for 2020.2 That’s a much more severe recession. The Federal Reserve issues a report a couple of times a year where they survey the presidents of the regional Federal Reserve Banks. That survey is showing a range of 2020 expectations for GDP from - 4.2% to -10%.3  Not only are those numbers horrific – the range is enormous. We are in a deep recession and it’s increasingly unlikely that there’s going to be a V-shaped recovery because we have not controlled the contagion. Cyclically, we would expect demand for office space would take a hit. It will play out slowly because there are long-term leases on office space, but we would expect that the current hit to employment – the unemployment rate is 11% and there’s a lot of complications around that – will add to the situation.4 I just read today that Moody’s is reporting that 414 companies are on watch for default. That’s 42% higher than in the great financial crisis.5 That takes a bite out of demand for office space, and it will only come back slowly as you recover from recession.

And what are the structural forces that are tugging in the opposite direction?

As we mentioned, people want more space in the office, and now we need to keep them farther apart, but there are some net negatives on the structural side some with increased costs due to improvements in ventilation and housekeeping. We’ll also see some slowdown in demand because some people want to work from home and because the labor force is growing ever more slowly. So, you have these competing forces on the demand side. I think you need to separate cyclical forces as being of maybe a shorter duration as we recover from the recession. Structural forces – more work from home, occupancy cost, slower labor force growth – those are longer term forces. Supply will adjust to demand. We have seen that over the last 20 years, and we didn’t have a lot of office construction between the 2008 recession and where we are now. We don’t have a lot of markets that have substantial new construction in their pipelines. Office space that doesn’t adjust to the need for better housekeeping, ventilation, and so on will very slowly fall out of the institutional universe and be converted to other uses. There are a lot of forces at work, and where it all lands over the next 10 years really depends on how those forces weave together – but we will have different offices, different degrees of intensity of use and probably very modest construction.

Would you say this is the most complex challenge for the office sector since you’ve been observing it?

Actually, no. During the 1991 recession – which was not as severe as the great financial crisis, and nowhere near as severe as where we are now – if you were in the commercial real estate business you thought it was the end of the world in ’91 and ’92. The mantra at that time was “Stayin’ alive until ’95,” because it was expected that was how long it would take until you could breathe a sigh of relief. There was over-construction, tremendous distressed debt, pressures on financial institutions, and the collapse of savings and loans. The current situation is less severe because monetary policy has embraced tools and a level of activity that is keeping a floor under distress.

There is also a tremendous amount of data in the commercial real estate business today, and tremendous transparency in the conditions across individual markets. That’s relatively new. Commercial real estate data was extremely sparse in the late 1980s when lenders were financing all of that over-construction. It just didn’t exist, and if you did have it, you didn’t share it. Data and transparency contribute to the ability of supply to adjust the changes in demand.

You mentioned the length of leases is helping to mitigate the current fallout in the sector. Do you think leases will become shorter in the future?

I do. I think that the world is moving faster, and that businesses will be more reluctant to sign long-term leases.

Where is Aegon AM seeing opportunity in the office sector over the short-, mid- and long-term?

In the short term, there’s still such enormous uncertainty. In the absence of properties with unique features, Aegon AM is holding until the situation evolves and we have more information.

In the medium term, we look for leasing activity and which locations we find attractive. That will be where we aim to focus dry powder. In the long-term, we look at how supply and demand are adjusting by location – how vacancy rates are landing as the economy comes back and as decisions are made regarding TBD office, versus suburban office, and more dense inner suburbs versus less dense office parks. That will shake out in terms of relative movements in vacancy rates.

Real assets have been an alternative for many investors over the years. What’s your differentiator?

Aegon AM has a long history in commercial real estate in general, and in the office sector. We’ve managed multiple cycles in the sector – we’re not novices. To support our business, we have experienced talent spread around various markets in the U.S., Europe, and in the U.K, and resources in loan servicing, research, and data and systems. We believe you need to have your resources in place and to be monitoring what’s going on out there in the marketplace.

Download the full paper referenced in this story.


1US Bureau of Economic Analysis – Real GDP. As of June 25, 2020.

2Blue Chip Economic Indicators® survey. July 10, 2020.

3The US Federal Reserve. June 10, 2020.

4Bureau of Labor Statistics. US Department of Labor. The Employment Situation-June 2020.

5Barron’s. 414 Companies Nearing Default, and Two More Numbers to Know. July 20, 2020.



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