New ESG Considerations For Commercial Real Estate Investors
In a post COVID-19 world, a two-hour commute to a large central office may be coming to an end. To understand why, let’s take a look at the new economics through an ESG lens.
Employee health and welfare have always been a concern for employers. A healthy workforce is a productive workforce. However, post COVID-19, employee health and welfare are now a concern for landlords as well. Not because landlords care more about their tenants, but because financial models in a post COVID-19 world have changed.
As landlords increased rents, tenants decreased office size and created open floor plans to fit more workers per square foot. The average office space per employee went from 300- 400sqf in 2010 to less than 200sqf today. A 6×6 foot cubical is 36sqf and imagine how many people can squeeze onto a trading desk? That was how the balance of rent vs employee costs (rent) remained in equilibrium.
Now social distancing enters the equation. Tenants need strategies to accommodate workers while keeping rents within budget. Landlords require higher rents to account for higher maintenance costs. Offices that were in high demand today may prove impractical tomorrow.
Ignoring commuting issues, below are common tenant strategies that address workplace safety. These include:
Moving back to individual offices and away from open floor plan configurations.
Staggering employee hours/days.
Disinfecting offices throughout the day and improving HVAC filtration.
Installing plastic partitions to isolate workers.
Moving away from a large centralized office space to a hub and spoke approach.
The hub and spoke approach address both workspace safety and employee commuting concerns. Satellite offices can be set up in the various suburbs at a fraction of the sqf cost while at the same time allowing employees to choose acceptable commuting options. Remote employees can periodically schedule time at the central office to attend meetings or use as a home base between external meetings. A form of this approach is currently being used by many professional service firms including some of the larger CPA firms. The hub and spoke approach is economical and alleviates many worker concerns.
Hub and Spoke Benefits
Reduces the daily commute time
Improves quality of life
Cost effective solution
Supports local communities
Decreases scope III GHG emissions
These are just a few tenant strategies to address COVID-19 but they illustrate how the traditional office space model may change today and into the foreseeable future.
Employee Health & Welfare Office Space ESG Factors
Individual offices as a percentage of total office seats
Average worker per rentable square foot
Percent of workforce using mass transit
Description of firms social distancing strategy
ESG integration is defined as using material ESG factors to help identify sources of risk and long term value. An ESG integration (aka Responsible Investment) strategy should consider ESG “employee health and welfare” factors and incorporate them into its investment process. These factors help identify risks to future cash flows and changes in valuation model assumptions.
Building owners and investors should also understand regional differences in how tenants institute workable social distancing. A spacious office in Texas that one drives to has a different profile than a dense New York office accessible only by mass transit. ESG factors can help shed light on whether building complexes like Hudson Yards become “stranded assets” or if office co-working arrangements such as WeWork are no longer sustainable business models. The answer is probably no, but the financial analysis used to evaluate these commercial real estate investments need to consider the people occupying the spaces more than ever.
These same ESG factors can also help investors identify opportunities. In a post COVID-19 world, satellite offices in surrounding towns may become the norm (and more valuable). At least for the foreseeable future, a segment of the workforce will not feel safe on mass transit, using common elevators or being in a crowed office. All of these concerns are alleviated by using a hub and spoke approach. Satellite offices may not be the next real estate play, but this example illustrates how changes in a tenant’s approach to employee health and welfare can affect a property’s valuation.
There’s no doubt COVID-19 posses a significant challenge for tenants and landlords alike. Until a vaccine is found (if ever) a segment of employees will not return to the traditional office arrangement. Using ESG factors is one way to understand the new landscape and possibly the new economics of commercial real estate.