Now's the Time to Buy Office Space

Ruth Saldanha: In this third part of our ongoing real estate series, we tackle commercial real estate, especially offices and the impact of working from home on downtowns. The sector took a beating during the COVID-19 pandemic and does not seem to have fully recovered yet. Is now a good time to buy commercial real estate? And will the sector ever recover? Brenda Lum is Managing Director of Credit Ratings at DBRS Morningstar, and she is here today to tell us what she thinks.

Brenda, thank you so much for being back with us today.

Brenda Lum: Thank you for having me.

What are Office Real Estate Vacancies Looking Like?

Saldanha: Let's start by talking about office real estate and the vacancy rates over there. What are the vacancies looking like right now?

Lum: Vacancies are higher, for sure. I think one of the challenges with the office space is that we just don't know what's going to happen. There's lots of uncertainty with respect to working from home, working from the office, how many days work from the office, what type of amenities there are for the actual tenants, and the design of the space. So, all of this uncertainty continues to lead to higher vacancies.

Will Office Real Estate Vacancies Stay High?

Saldanha: And what's the trend looking like? Do you think the vacancies will continue to stay high going ahead?

Lum: I do. I do. I think until we get some clarity on where we want to move to in terms of number of days at the office, or maybe not. Maybe we'll just be in this period of uncertainty for a while. The primary reason I think that we're going to be in this uncertainty is because there are leases that will come due in the next year or two years. So, that will add to the vacancies, because not all space is being used. Yes, rents are being paid, but some of it's pretty empty.

Which Commercial Real Estate Spaces Have Been Doing Well?

Saldanha: You have a bird's eye view of the entire office space right now. Are there any areas that have been doing well, and any that have not been doing as well right now that you've been seeing?

Lum: I think the super regional malls have been doing well. I think the grocery-anchored retail spaces are doing well. I also think that any necessity-based retail is doing well. It's because these, excluding the super regional malls, the other two really have a basis for individuals to have to come to buy their groceries. I personally like to shop for my produce because I like to pick up my vegetables and fruits. But throughout the pandemic, it hasn't been disintermediated, where the actual shopper will get all of their groceries online. They may get some, but not all of it. So, they're still going into these grocery-anchored locations. As a result, the traffic is also inducing them to go to other shops that are attached to this grocery-anchored mall.

Which Office Real Estate Spaces Have Been Doing Well?

Saldanha: From an office standpoint, are there any office buildings that are doing well right now, and any that are not doing so well?

Lum: Yes. I would say from an office perspective, those that are new have lots of good amenities and even ESG, so they have strong environmental guidance, I think they're going to do really well. And the primary reason is because the tenants want to be there. They want to showcase this. They use that building or their location as a point of attraction for new employees. I think the buildings that are going to lose out are those that are Class B, like older buildings that need to be upgraded to provide some of these amenities, not necessarily because of anything other than the fact that we are going to see rents probably abate. And as a result, tenants who were once paying X dollars probably can get something better now for the same price. So, why not move up to a higher-quality building with more amenities?

What are the Risks in Office Real Estate Right Now?

Saldanha: So, that makes sense. Are there any risks that you're looking at in office real estate right now that investors should keep an eye on and be cautious about?

Lum: Yes. I think in terms of risk, I would say probably on the sidelines for office, I think there's way too much uncertainty right now. I think some of the risks will involve what the actual employers decide to do. We're still in a very tight employment market. And so, whatever they can do to attract employees, that will have a bearing on the office sector. Additionally, on the office side, I think that some of the risks would involve the actual economy because real estate is a laggard. So, if we see the economy slowing, then that can have an impact on performance of businesses and on office space.

Where Are the Good Deals in Office Real Estate?

Saldanha: Well, with the entire sector being so depressed at this point, is it a good time for investors to consider getting into real estate? Are there any good deals to be had right now?

Lum: I think there are good deals. The question is whether the sellers want to sell at that price. We haven't had a lot of price discovery. So that means that there haven't been a lot of sales where the prices provide some stability in where the market is going. And I really don't think – I think the owners right now still feel like they should be getting top price, and I think the buyers feel like they should be getting bottom price.

Saldanha: That makes sense. Thank you so much for joining us with your perspectives, Brenda.

Lum: Thank you.

Saldanha: For Morningstar, I'm Ruth Saldanha.