Office Vacancy Records – Secular Change or Extra-Cyclicality?
When the COVID -19 Pandemic hit, it was a true ‘Black Swan” event. No-one could have predicted its likelihood, magnitude, or long-term impact. The global response of course sent most workers home and tested digital communications tools in ways that we otherwise never would have. Certainly, these tools had been on the rise for a decade, but without a full-scale test, Zoom, Teams, Blue Jeans, WebEx, etc. would have remained tools we used for small events and presentations. The longer-term effects of course are still to be determined, but the most obvious question remains…does the global workforce have to return to the office, and if not, what will happen to the real estate that has traditionally housed those workers? This past week, The Wall Street Journal published a story highlighting the fact that office vacancies are at their all-time high according to Moody’s Analytics. Moody’s has been measuring these statistics since the late 1970s and the US currently sits at a 19.6% vacancy rate as can be seen in the chart below.
We felt it might be instructive to go through the various peaks and valleys over the last 4 decades to start to answer the question of secular change vs. cyclicality. Previous highs in the late 1980s and early 1990s followed periods of overbuilding that were triggered by Reagan era tax law changes. These changes allowed acceleration of depreciation of buildings and encouraged investment in commercial development that ultimately triggered the Savings and Loan Crisis. The subsequent improvement in vacancy rate can be attributed to the dot com era boom. A worsening in vacancy followed the terrorist attacks of September 11th. Things got better until the Global Financial Crisis and then again afterward, even though it happened at a lesser magnitude. Finally, as video communications got better AND the pandemic acted like gasoline on a fire, vacancies finally accelerated to their worst levels of all time. What follows is still to be determined and it is very logical for investors to look at this chart and see a trend line toward higher vacancies over time. However, as is true anytime we measure data, the beginning and end points matter a lot. In this particular case, the reason the US incentivized commercial building was because we were woefully short office space in the early 1980s, and interest rates were abnormally high to fight massive inflation. If we remove the earliest data from the analysis, the data appears far more cyclical than secular. If in fact this is a cyclical high in vacancy, should we not be thinking about investing when we know that future build rates for offices are likely to decline materially? Clearly the logical investor would start shopping for office buildings that may be trading for cents on the dollar (which many are right now).
We do not claim to have all the answers to the office market’s current doldrums. What we do know, is that among the fundamental truths of investing is that there is rarely a time when every asset within an asset class is un-investable. There are simply too many assets within each asset class, and fundamentals differ for every asset even if there are overarching themes within a class. Said another way, there is ALWAYS something attractive to invest in. Those that believe that secular change has permanently affected office investing will ultimately push pricing so low that it will encourage investment. Will equilibrium look the way it has in the past? Perhaps not, but those that give up on the class will ultimately ensure its cyclicality.
https://jabberwocking.com/the-increase-in-the-office-vacancy-rate-isnt-really-a-pandemic-phenomenon/
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