How does the "death of the office" affect the average person?

Mapping the flow of money from the $22tn global office space sector

Tl;dr (summary)

• Office space globally is a $22tn asset class, worth more than even the largest single economy in the world

• The vast majority of us are dependent upon the economics of office space in some way, due to the sizeable ownership of office space by pension funds, insurance companies, banks and investment funds

• The reduction in office use is likely to have a seismic effect due to the sheer size of the asset class

• The sector became so large because investing in it has been known as a “no brainer” for decades

• The effects won’t be immediate, due to the fact there was under-supply of office space in major cities for the past few years & the vast majority of occupiers are locked into long-term leases

• Even as the long-term effects play out, there is unlikely to be a binary “exit” from the office sector

• How office use cases change and how landlords react will be key to the resilience of the sector

There’s been a huge debate around the “death of the office” since the initial lockdown. Whilst no-one can predict exactly how this will play out, what’s becoming very obvious, very quickly is that office use in the traditional sense will decline post-Covid, compared to pre-Covid.

Our own survey at HubbleHQ, with over 1,000 responses from 100s of businesses across the UK, yielded the conclusion that we may only need 34% of the office space we had pre-Covid (but we may want more or different versions of it).

Valued at a whopping a $22tn, a reduction in use of this asset class has consequences at a colossal scale for the global economy. As consumers, investors and savers, we are more affected by this than we think. It is reasonable to assume that decline in office use will impact the income and wealth of the average person.

I wanted to take a moment to map out the effects of reducing office footprint on all the stakeholders involved, and get a sense of the chain reaction this may kick off. Before I get into it, worth making a few things clear:

What this post IS: A thought experiment into how a reduction of office use creates a chain reaction due to the interdependence between a huge number of stakeholders.

What this post IS NOT:

1. A call to arms to go back to the office because it’s our civic duty. I don’t believe that and I don’t advocate for that. I am very publicly the only office space CEO saying that the office, as we knew it, is dead (afaik).

2. A fully calculated and weighted map of the effects. Adding in the ownership stakes and risk levels for each of the stakeholders will add another crucial dimension to this thinking. I haven’t done this here for the sake of simplicity (and time).

Mapping the flow of office rent

I’ve used my new favourite remote work tool (Miro) to map out my version of the office rental flow (image below).

For a closer look and to leave comments, I’ve shared a live Miro mind-mapping link. This is very much a think-piece in progress rather than the finished article. Any help / comments / thoughts are very welcome here.

Key stakeholders

Looking on the mind map above, you can see the degree of interdependence between different parties and how it can eventually be mapped back to “you and me”. The key stakeholders are:”

1. Businesses who pay rent - office space is typically the second largest fixed cost for most businesses. If they start to spend less on office, or use that money differently, this will have a huge effect on aggregate.

2. Office operators - the majority of office operators (WeWork / Regus etc) are typically tenants of traditional landlords. If they collect less rent, it will affect their ability to maintain their own business, pay their suppliers and the landlords.

3. Office landlords - office landlords are typically public or private property companies, public bodies, pension funds, insurers, banks, investment funds and wealthy families. Most of the investors are investing money on behalf of corporations or individuals via pension & investment funds. Their inability to meet liabilities and any decreases in asset value poses the biggest risk in the chain back to the average person.

How big is $22tn?

$22tn is such a large number, it almost feels made up. And it kind of is, kind of isn’t.

The $22tn figure comes from Dror Poleg’s book Rethinking Real Estate: A Roadmap to Technology’s Impact on the World’s Largest Asset Class. His figure comes from the estimate that the global real estate market is worth $200tn, of which 30% is commercial real estate and 40% of that is the office. This asset class is so large and so vast, actually figuring out its size is impossible even for one of the leading researchers in the sector.

To get a sense of how big $22tn is relative to other things we do know:

• The equity value of all the global stock markets combined is around $90tn

• USA has the highest GDP in the world at $19.5tn

• The combined market cap of the biggest technology companies in the world (FAANG - Facebook, Apple, Amazon, Netflix, Google) is around $6tn

• So office space is worth around 24% of all stock markets in the world, more than the GDP of wealthiest country in the world and about 4x the size of the largest technology companies in the world, combined.

The reason why the size of the sector is so important, is because even small shifts in this market can create second, third, fourth order effects of seismic proportions. Some could even argue that the collapse of the sector is a systemic risk to the global economy due to the sheer size and interdependence.

How does this affect the average person?

The shortest & most direct answer is that most of us likely rely on either the value of office buildings or the income from office rent without knowing it. The largest landlords of office space around the world (and particularly in London) are institutional investors such as pension & investment funds, insurers and banks.

If the likes of AXA, Aviva and Fidelity start to see the value of their office buildings drop and the income from office rent dry up, this will directly affect the value of your savings and pension and their ability to make regular payouts.

The longer answer is best seen by looking at the mind mapping above. Nearly all roads lead back to the pockets of you and me. Of course, this is just how capitalism works - however, the sheer scale of the sector means that each stakeholder is more likely to feel the effects of the death of the office than a similar size change in a smaller sector.

How did the office sector become so large?

High ROI, low-risk, stable, predictable, long-term income.

Whisper these words gently and softly into the ears of any investor and you’ll get them very excited.

Office space has all these characteristics due to a 3 key factors, which have started to change over the past 10 yrs and will change drastically over the next 10 yrs (if not the next 10 months):

1. Traditional office lease lengths: the shortest tend to be around 3yrs and the longest up to around 30yrs, with the average in London and most major US cities sitting around 7 - 15yrs. This creates stable, predictable, long-term income.

2. Blue-chip occupiers: every landlords wants a low-risk, blue chip occupier with a low risk of default. Typically, taking an office lease requires a huge amount of due diligence to assess the ability of the business to commit to rental liabilities over a long time horizon. This creates low-risk income.

3. Densification within city centres: location, location, location has long been the mantra of most property investors and office in no exception. Over the past 50yrs+ we have seen an evolution towards city centres and supercities. This has driven up prices with relatively high predictability - creating high ROI investments.

All 3 of these key assumptions are now under attack as businesses start to question everything about their office - who, what, when, where and why. These questions were already being asked pre-Covid, but they have been accelerated hugely by the existential crisis that Covid has created for the office sector.

What happens now?

Well, not much has happened over the past 6 months, office rental prices have remained relatively stable despite the turbulence and occupancy hasn’t changed significantly - but - things will start to pick up steam next year.

The reason is that pre-Covid, the office market in most large, successful cities such as London, New York, Paris, Hong Kong was overheating due to huge demand, that supply could not keep up with.

Also, the vast majority of office space in those cities has been taken on longer-term leases, some of which will start to come up for breaks, expiries and renewals. If Covid does in fact have a long-lasting factor for demand for office space, businesses will either pay huge fees to try and get renegotiate / restructure their lease, or start exercising breaks when they come up.

However, this is not as straightforward as a full exit from the office for most businesses. The majority of businesses are likely to keep an office, but have a smaller or more flexible footprint than before, so demand for long-term, large office spaces will reduce and be replaced by demand for short-term, flexible spaces.

Of course, there will also still be some businesses like Google, Dropbox and Netflix who keep the same footprint, or even increase it, but evolve the design of their spaces to better enable the sort of work people want to do in-person - we call these the three C’s: collaboration, colleagues and clients.

How quickly the office market can react to this change in demand, will determine how resilient it is to these shifts and how much of the $22tn value remains.