The Future of Office …
Or the Office of the Future?
John McCarthy, CEO, Starwood Real Estate Income Trust
COVID-19 has brought great uncertainty and change, which has impacted virtually every aspect of our daily lives. It has profoundly affected the global economy, including business, healthcare, education, travel, government and naturally where and how we work. Some of the changes brought by COVID-19 will have a lasting effect and some will be more temporary. Determining which changes will last will be challenging, but necessary to be prepared for what lies ahead.
This article specifically addresses the changes COVID-19 has brought to “how and where we work” and its impact on office properties. Even before COVID-19, there was a movement across the U.S. workforce to work more from home. The Federal Reserve estimates that work from home has tripled over the last 15 years. This change has been driven largely by the high cost of living in many dense urban areas which extends commuting times, along with an increase in the quality of technology which allows for better remote collaboration.
As COVID-19 fades, many aspects of working in offices will return to what they were, but the need for flexibility will create potential winners and losers. We know employees will want greater flexibility and better accommodations. We will focus on the drivers of this potential change. Some will be positive for office demand, while others may be negative.
Potential Changes Impacting Demand for Office:
Work from Home Decreases the Demand for Office: When COVID-19 forced a substantial portion of the U.S. workforce to shelter in place and work from home, it forced employees and managers alike to test the theory that workers could be productive working from home. By almost all accounts, the forced experiment has resulted in greater comfort with employee productivity while working remotely. The obvious extension of this is less demand for office space, as certain workers are offered the flexibility to regularly or periodically work from home.
Important questions remain: What kinds of work can be done at home? Reports have indicated close to 40% of all jobs could plausibly be done at home. That leads to another question: How many actually want to work from home? A recent survey by Gensler Research (“Gensler U.S. Work from Home Survey 2020”) determined only 12% of office workers want to work from home. Several studies suggest after many months of working from home, employees miss the daily interaction with their coworkers and having specific working hours. The Gensler Survey indicated 74% of respondents say the people is what they miss most about the office. Whatever the eventual outcome, we know that some portion of the workforce will have permanent or periodic flexibility to work from home, which may negatively impact future demand for office.
Reversal of Densification: Of the factors effecting demand and usage of office space, the one that may be the least controversial is the densification of office space that has occurred over the past 20 years will reverse. Social distancing and the need for generally more distance between employees requires more space, more elevators, and larger common areas.
Office space peaked at around 225 square feet (“s.f.”) per employee in the early 1990s. That figure dropped to less than 200 s.f. per employee by 2019, approx. a 15% decline. By way of example, if New York City or Boston de-densify just to 1990s level of 225 s.f. per person, it would require 86 million and 12 million s.f. of new leasing, respectively. That’s a lot of leasing. It seems clear that de-densification will increase the demand for office space.
Square feet per employee (U.S. companies)
Source: Adrian Ponsen, CoStar Group
From: "The Truth About Open Offices." by Ethan Bernstein and Ben Waber, November-December 2019
Flexible Spoke and Hub Office: Employers will de-centralize and offer more flexible work locations: Flexible suburban work locations may never fully replace urban locations, but we believe employees will expect more flexibility from their work locations in the future. Having enjoyed zero length commutes, employees will demand work locations that offer shorter commutes and properties that assure a greater level of health and wellness. A recent study suggests that pre-COVID-19, the average commute in the U.S. had reached 27 minutes each way, and traditional big city urban centers often demand commutes far longer. Workers, post COVID-19, will be less tolerant of longer, inconvenient commutes, especially if they involve over-crowded mass transit and poor quality office product.
This suggests employers, especially larger employers, will identify strategically located satellite locations where employees can shorten commute times, have access to better open spaces, more elevators and enjoy an overall higher quality work experience. This suggests the demand for office may increase as satellite locations are added to central office hub locations.
Quality Counts: In the post-COVID-19 future we believe both employers and workers will demand better quality accommodation with features like high floor to ceiling ratios, large amounts of natural light, operable windows, higher quality air purification and circulation, larger more useful common areas, higher elevator counts, separate entrances, private outdoor spaces and better floorplates. We believe this increased demand will result in a premium being placed on higher quality locations and properties.
Cracks Emerging in Work from Home: Now that work from home has been occurring for a period of time, cracks are starting to show: Work takes longer, hiring and training new staff is challenging, younger professionals may not be assimilating to company culture or embracing company values, and mental health issues are becoming discussed more frequently as the lines between work and personal life become blurred.
During the COVID-19 lockdown, employees who were asked to work from home benefitted from the pre-existing relationships that were developed… in the office. We believe the spontaneous interaction between employees, which occurs in the office, is critical towards developing trusting co-worker relationships, and ultimately in-person interaction is how company values and culture are learned.
Consider a 2019 study completed by a Fortune 500 firm, which concluded that just 10% of all employee communications occurred between employees whose desks were more than 50 feet apart. Another study completed at a technology firm indicated remote workers communicated 80% less about their assignments than co-located team members did. In 17% of the projects measured, non-co-located team members didn’t communicate at all.
We believe during COVID-19, senior managers will allow flexibility for employees to work from home for a period of time for safety, but will not likely emerge as managers or business owners preferred long term solution. This may mitigate the ultimate impact of work from home.
The push and pull of these factors on office will not be clear for some time. In the interim, new construction of office space will materially slow or cease across the U.S. until the outcome becomes clearer. We believe the higher quality properties with more flexible floor plans will have an advantage. As employers look to rationalize their office footprint, we are certain they will favor more affordable, low cost markets where workers can enjoy a high standard of living, with generally shorter commute times. Ultimately, certain firms may reduce their office footprint, while others take more space to lessen worker density. Employers may also offer additional satellite locations for workers to shorten commutes and increase flexibility. Post COVID-19, employees will expect to return to a different workplace with more space, less desk sharing and increased technological support to enable flexible work from home.
During the evolution to this “new normal” we believe (a) over the long run, job growth will create incremental demand for office space, (b) an outsized portion of that job growth will be in affordable, low tax / low cost markets, (c) higher quality, Class A properties will capture an outsized portion of demand, and (d) those properties with long in-place leases will provide a strong performance buffer and serve to protect investment value.
What does this mean for Starwood Real Estate Income Trust (“SREIT”)?
We believe we are well positioned to take advantage of these future trends. Office represents approximately 30% of SREIT’s total assets under management. Historically, when acquiring office properties, SREIT focused on (i) quality locations with substantial demand drivers, principally strong population and job growth, (ii) long in-place leases, (iii) high concentration of credit tenants, (iv) properties with in-place rents substantially lower than market rents, (v) and emerging low cost growth markets.
Metrics on SREIT’s office investments are summarized below:
SREIT’s Office Metrics
Data as of June 30, 2020
of total SREIT assets
levered cash yield
of average lease length
average remaining debt term
of our leases are to investment grade
credit tenants, private industry leaders,
and/or top credit health scores1
The value of SREIT’s office properties is highly concentrated in two specific assets located in Boston, MA and Nashville, TN2:
60 State Street
Acquisition Date: March 2020
• Boston was the #1 top metro market for office rent growth in 2019, increasing by 11%
• SREIT acquired an A quality 91% occupied building with an 8.5 year weighted average lease expiry and in place rents 20% less than market rents
• 60 State Street is widely considered among the top 3 to 5 properties in Boston based on location and quality
Acquisition Date: February 2020
• Located in Nashville, TN, which is an attractive low cost market that is experiencing substantial job growth, SREIT acquired a 2017 completed property that was 100% occupied with average lease expiry of 10 years
• 84% of the tenant income is credit quality
• The property, given its 2017 vintage, is among the top quality properties in the market
Starwood Capital Group is one of the world’s leading real estate managers, with over $60B of AUM and 29 years of experience navigating through numerous market cycles. Our team of seasoned real estate professionals is monitoring this asset class very closely. We will continue to work tirelessly to protect investors’ capital, while also looking to take advantage of select investment opportunities this environment will create for SREIT.
Learn more about our market insights and investment process
A credit health score, calculated by S&P Global Market Intelligence, evaluates the creditworthiness of a chosen company relative to a unique group of industry peers. A “top” rating indicates top quartile relative to peer set. The data includes more than 240,000 companies, including some that are rated by S&P global ratings, as well as those that do not have an S&P global ratings value.
The other office space in SREIT’s portfolio is located in Jacksonville, FL, and Columbus, OH. For a full listing of all SREIT investments, please visit www.starwoodnav.reit/investments.
Summary of risk factors
An investment in Starwood Real Estate Income Trust, Inc. involves a high degree of risk. You should purchase these securities only if you can afford the complete loss of your investment. You should carefully read the information set forth in the “Risk Factors” section of the prospectus before buying our shares. Risks include, but are not limited to:
- We have a limited operating history and there is no assurance that we will achieve our investment objectives.
- We have made limited investments to date and you will not have the opportunity to evaluate our future investments before we make them.
- Since there is no public trading market for shares of our common stock, repurchase of shares by us will likely be the only way to dispose of your shares. Our share repurchase plan provides stockholders with the opportunity to request that we repurchase their shares on a monthly basis, but we are not obligated to repurchase any shares and may choose to repurchase only some, or even none, of the shares that have been requested to be repurchased in any particular month in our discretion. In addition, repurchases are subject to available liquidity and other significant restrictions. Further, our board of directors may modify, suspend or terminate our share repurchase plan if it deems such action to be in our best interest and the best interest of our stockholders. As a result, our shares should be considered as having only limited liquidity and at times may be illiquid.
- We cannot guarantee that we will make distributions, and if we do we may fund such distributions from sources other than cash flow from operations, including, without limitation, the sale of assets, borrowings, return of capital or offering proceeds, and we have no limits on the amounts we may pay from such sources.
- The purchase and repurchase price for shares of our common stock are generally based on our prior month’s NAV and are not based on any public trading market. While there is independent periodic appraisals of our properties, the appraisal of properties is inherently subjective, and our NAV may not accurately reflect the actual price at which our properties could be liquidated on any given day.
- We have no employees and are dependent on Starwood REIT Advisors, L.L.C. (the “Advisor”) to conduct our operations. The Advisor will face conflicts of interest as a result of, among other things, the allocation of investment opportunities among us and Other Starwood Accounts (as defined in the prospectus), the allocation of time of its investment professionals and the substantial fees that we pay to the Advisor.
- This is a “best efforts” offering. If we are not able to raise a substantial amount of capital on an ongoing basis, our ability to achieve our investment objectives could be adversely affected.
- There are limits on the ownership and transferability of our shares.
- If we fail to qualify as a REIT and no relief provisions apply, our NAV and cash available for distribution to our stockholders could materially decrease.
- The acquisition of properties may be financed in substantial part by debt. The use of leverage involves a high degree of financial risk and will increase the exposure of the investments to adverse economic factors.
- Investing in commercial real estate assets involves certain risks, including, but not limited to: changes values caused by global, national, regional or local economic performance, the performance of the real estate sector, unemployment, stock market volatility and other impacts of the recent coronavirus pandemic, demographic or capital market conditions; increases in interest rates and lack of availability of financing; vacancies, fluctuations in the average occupancy and room rates for hotel properties; and bankruptcies, financial difficulties or lease defaults by our tenants.
- Management fees and distribution fees are substantial and will reduce your investment returns.
- A change in U.S. tax laws could adversely impact benefits of investing in our shares.
- Disposition of U.S. real property interests by non-U.S. persons is subject to income tax withholding. As a result, investment in our shares may not be appropriate for non-U.S. investors.
This sales and advertising literature does not constitute an offer to sell nor a solicitation of an offer to buy or sell securities. An offering is made only by the prospectus. This material must be read in conjunction with the Starwood Real Estate Income Trust, Inc. prospectus in order to fully understand all of the implications and risks of the offering of securities to which the prospectus relates. A copy of the prospectus must be made available to you in connection with any offering. No offering is made except by a prospectus filed with the Department of Law of the State of New York. Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of our securities or determined if our prospectus is truthful or complete. Neither the Attorney General of the State of New York nor the Securities Division of the Office of the Maryland Attorney General has passed on or endorsed the merits of this offering. Any representation to the contrary is a criminal offense.