u.s. office workplace survey: reduced, reconfigured, but

REAL ASSETS RESEARCH & INVESTING TEAM

AUTHORS

REAL ASSETS | REAL ASSETS INVESTING TEAM | INVESTMENT INSIGHT | 2021

The office sector is the largest investable commercial real estate segment in the U.S. ($2.6T)1 and represents the highest investment allocation among institutional investors (33%).2 Yet, the sector has experienced the most dramatic change in physical occupancy throughout the pandemic due to the requirement for employees to work from home (WFH). The question on the mind of every market participant is: could WFH models and shifting occupier preferences push the office sector into secular decline, similar to the impact of e-commerce on the retail sector? Despite all of the anecdotes, company announcements and brokerage surveys that address this topic, a consensus view has yet to emerge. Morgan Stanley Real Estate Investing (MSREI) decided to take on this question ourselves, by partnering with Morgan Stanley’s Equity Research team and leveraging the breadth of Morgan Stanley’s Investment Banking relationships with corporate clients. The overall conclusion from the survey and our own analysis is that, while WFH will increase from pre-COVID levels, the office will remain the centerpiece of “hybrid” work models adopted by most corporations. When the dust settles, the office sector will continue to attract significant capital from institutional investors. However, location, specifications and property quality will become even more important factors impacting investment selection and the underwriting process. Although not covered by the survey, we believe that office markets outside the U.S. may be more or less susceptible to WFH trends, with countries like Japan, China and South Korea potentially less impacted, while certain markets and industries in Europe may be more willing to adopt hybrid models to reduce costs.

1 Costar, May 20212 NCREIF, May 2021

U.S. Office Workplace Survey: Reduced, Reconfigured, but Still Required

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INVESTMENT INSIGHT

MORGAN STANLEY INVESTMENT MANAGEMENT | REAL ASSETS

Morgan Stanley conducted a proprietary, quantitative survey of one hundred U.S. corporates across all sizes and sectors, and a number of qualitative interviews, to better understand the potential impacts of hybrid work models on office demand. Below are the major findings:

• WFH penetration in the U.S. is currently expected to double vs. pre-COVID levels

• Companies may adopt a variety of location strategies and WFH playbooks. Shifting from high-cost to low-cost locations (for a small percentage of employees) and middle/back-office functions to WFH being cited the most

• De-densification (adding more space per worker) is not a consistent theme, with two thirds of respondents indicating that space per employee is currently expected to stay the same or decrease

• 13% of office space could be given back over the next three years as leases roll

• Technology investment (both in-office and at-home) will increase to support hybrid work models, with a particular focus on video conferencing

1. Expect 2x increase in WFH penetration vs pre-COVID levelsThe survey results found that WFH penetration is expected to increase, with the percentage of employers stating that 25% of their workforce could WFH 3+ days per week increasing 3x from 21% pre-COVID to 63% post-COVID. While at the other end of the spectrum, the percentage of employers citing 5% of their workforce will WFH dropped ~5x from 67% pre-COVID to 13% post-COVID. Overall, WFH penetration (defined as the % of employees who WFH 3+ days per week) is expected to increase by a minimum of two times compared to pre-COVID levels, i.e., an increase from 16% to 35%.

2. Variety of Location and WFH Strategies Idiosyncratic to Each CompanyEmployers plan to adopt a variety of location and WFH strategies for their office space post pandemic. Shifting employees from high-cost to low-cost locations was cited the most by respondents (45%). However, within those respondents, 43% stated they would shift only a small percentage of employees (<10%), with only 3% stating they would

shift more than 20% of their employees. Unsurprisingly, from conversations with technology companies, the need to be close to the best talent will continue to support demand in high cost locations like San Francisco and New York, resulting in them maintaining a similar office footprint in those cities going forward. At the same time, these technology companies will likely grow their footprint in lower cost cities as they expand their overall employee base. Recent corporate announcements and moves support this trend, with Oracle lobbying for incentives to build a 1.2 million SF office campus in Nashville and Apple expecting to complete construction of its largest U.S. office campus in Austin by the end of next year.

Moving middle and back office jobs to a WFH model was cited by 42% of companies, given the cost savings and perceived lower need for face-to-face collaboration in these functions. In many instances, given these functions are housed in Class B and more “commodity” style assets or secondary locations, the shift to WFH may disproportionately impact these segments of the office market.

Lastly, while still noted as an important consideration, only 25% of companies

DISPLAY 1Majority of Employers plan to WFH 3+ Days per Week% of Employers Stating that 25% (or 5%) of their Workforce WFH 3+ Days per Week, pre vs post-COVID

■ Pre-COVID ■ Post COVID

25% of Workforce WFH3+ Days per Week

5% of Workforce WFH3+ Days per Week

67%

13%21%

63%

Source: MS Workspace Strategy Survey of 100 Corporates, April 2021

DISPLAY 2WFH Penetration will increase 2X% of Workforce WFH 3 days+ per week

■ Pre-COVID ■ Post COVID

<5%

44%

3%

32%

10%

23%

17%

30%25%

12%

4%

16%

35%

11-25% Average26-50% 51%+5-10%

Source: MS Workspace Strategy Survey of 100 Corporates, April 2021

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U.S. OFFICE WORKPLACE SURVEY: REDUCED, RECONFIGURED, BUT STILL REQUIRED

REAL ASSETS | MORGAN STANLEY INVESTMENT MANAGEMENT

suggested they will be shifting employees to suburban or satellite office locations. Maintaining a distributed “hub and spoke” model creates challenges for building a consistent corporate culture and many suburban locations have inferior transportation linkages and walkable amenities when compared with central/CBD locations, potentially making it harder to attract and retain talent.

3. Employers Currently do not Plan to De-Densify Office SpaceDe-densification, or adding more space per employee, has been touted as a likely offset to higher WFH penetration levels, given the relatively high levels of density that has been common in many office buildings pre-COVID. Office square footage per employee had fallen by approximately 15% over the past 10 years,3 due in part to the acceleration of coworking models but also driven by employers’ desire to reduce real estate costs per employee. Counterintuitively, the survey found that while 34% of employers said they would likely increase the square footage per employee (by an average of 24%), 33% said they would decrease the amount of space per employee (by an average of 17%), while 33% suggested they would maintain the status quo. This can perhaps be explained by the employers’ desire to reconfigure their footprint, increasing the proportion of larger dimensioned shared/collaborative space and reducing the relative share of smaller sized private offices/workstations.

4. 10-15% of office space likely to be given back The combination of fewer days in the office and changes in square footage per employee translates into an overall impact on office demand. However, with the need to support peak usage and flexible schedules, 25% of employees wanting to WFH 3+ days per week does not automatically translate into a 25% reduction in office demand. To

3 Costar, data as at May 2021

DISPLAY 3Impact of Employee Location/Function on WFH StrategyWhat are your post-COVID employee location strategies?

Shist to suburban/satellite offices

Increase WFH inhigh-cost cities

Shist more middle andback office to WFH

Shist from high-costto low-cost cities

25%

38%

40%

45%

42%

Shist smallerlocations to WFH

43% statedthey would

shist <10% ofemployees

Source: MS Workplace Strategy Survey of 100 Corporates, April 2021

DISPLAY 4Office Density Could Remain the SameHow do you anticipate your SF per employee changing?

● Increase (by average of 24%) 34%

● Maintain 33%

● Decrease (by average of 17%) 33%


DISPLAY 5Employers Currently Plan to Reduce Office FootprintsHow do you anticipate your overall footprint needs will change over the next 3 years?

● Increase 10%

● Maintain 19%

● Reduce 1-10% 12%

● Reduce 11-20% 26%

● Reduce 21-30% 17%

● Reduce 30%+ 16%

Average reduction of 10-15%


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INVESTMENT INSIGHT


the question “How do you anticipate your overall office footprint/office space needs changing over the next three years?” 71% of responding employers said they currently expect to reduce their overall office footprint, 19% said they expect to maintain their current footprint and 10% said they expect to increase their footprint. Factoring in the detailed estimates of the respondents, Morgan Stanley’s survey determined that, more broadly, there could be a give-back of 13% of office space. Supplemental conversations revealed that lower growth/mature companies will likely make larger cuts to office space versus high growth companies that will likely continue to grow, albeit in a more measured way. This is relatively consistent with other real estate surveys. To support flexible work scheduling and enable the reduction in office space, 62% of employers plan to increase the number of hoteling desks within their organization.

The survey also found that smaller companies were more likely to shed space. 73% of smaller companies (defined as $500MM to $1B in annual revenue) answered that they would reduce their office footprint compared to 64% of

larger companies ($10B+ of revenue). Additionally, only 3% of smaller companies said they would increase space versus 23% of larger companies.

5. Increased Technology Spend to Support Hybrid Work ModelsTechnology investment will continue to accelerate to support the variety of WFH models and return-to-work styles. For example, 56% of employers surveyed expect to invest more in video rooms to enable workforce collaboration, 51% plan to invest in better wireless capabilities and 46% plan to invest in better PC hardware and accessories. Additionally, at-home security, collaboration and connectivity will be key areas of technology investment over the next twelve months.

ConclusionIn conclusion, given the pandemic forced corporations to adopt a WFH model out of necessity (not preference), it remains to be seen how sticky this model will be once the workforce is vaccinated, occupation levels increase and normal leasing activity resumes. MSREI believes that offices will remain a critical component for most

corporations to support collaboration, creativity, mentoring and culture. Additionally, as the U.S. continues its rapid macroeconomic recovery, strong job growth could offset some of the reduction in office demand from WFH in the near to medium term. Some sectors, functions and markets may be more (or less) conducive to WFH models, but overall, we believe that high quality office assets, with the right specifications and amenities in the best locations, will continue to outperform and attract a greater share of potentially lower overall demand. Technology (wireless, video, remote connectivity), health and sustainability will be key asset differentiators. Commodity assets in secondary locations, however, are more vulnerable to the considerable headwinds facing the sector and, in our view, are likely to underperform as a result of these shifting trends. MSREI will continue to selectively invest in the office sector, targeting assets in good locations and implementing quality improvements (physical building attributes, amenities, ESG standards) that can be executed through rigorous asset management activities.

DISPLAY 6In-Office Technology Investment Plans Next 12 MonthsWhat technology investments will be needed to “ future proof” offices?

Video rooms tosupport collaboration

Betterwireless access

Change phone systemfor hoteling set-up

56%

51%

46%

29%

PC hardwareand accessories


DISPLAY 7At-Home Technology Investment Plans Next 12 MonthsWhat technology investments will be needed to support at-home set-ups?

Additionalcollaboration tools

Better security

Standardized at-homecomputing set-ups

55%

50%

49%

44%

Standardized at-homeconnectivity set-ups


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Appendix: Survey Methodology and Sample

DISPLAY 8Sample Profile: Industry Segment (Among Total)

Business Services

Information Technology (IT)

Financial Services

Telecom

26%

25%

21%

4%

21%

Consumer Packaged Goods (CPG)

Media 3%

DISPLAY 9Sample Profile: Title (Among Total)

● CHRO 12%

● Other 5%

● COO 28%

● CFO 20%

● VP of HR 18%

● CEO 17%

DISPLAY 10Sample Profile: Annual Revenue (Among Total)

● $10 Billion to more 22%

● $500 Million to less 30% than $1 Billion

● $1 Billion to less 48% than $10 Billion

Morgan Stanley conducted an online survey in the beginning of March 2021 among 100 corporates headquartered in the United States.

• 28% of the sample are COOs, 20% CFOs, 18% VP of HR and 17% CEOs.

• All companies have revenue over $500 million, with 30% $500 Million to less than $1 Billion, 48% $1 Billion to less than $10 Billion and 22% $10 Billion or more.

• We targeted companies in 4 key industries: Business Services (26%), IT (25%), CPG (21%) and Financial Services (21%).

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INVESTMENT INSIGHT


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u.s. office workplace survey: reduced, reconfigured, but

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