Newer Office Buildings Will Excel in COVID-Era Market, Investor Says

As most office employees continue to work from home, the coronavirus pandemic’s potential long-term impact on the physical workplace remains up in the air.

“The office market is really the biggest question mark that everyone has right now,” says Gregory Freedman, co-founder of real estate investment and development firm BH3. Freedman oversees investments, financial analysis and capital markets for the firm, which operates in New York City and South Florida.

To remain successful, office buildings will need to be repositioned to meet tenant demands for the new normal, incorporating COVID-19-conscious features and prioritizing health in the workplace through building design. For Freedman, this means new building stock will come out ahead.

“The pandemic forced real estate developers to take an abrupt pause and rethink projects of all uses,” he says. “Real estate is no longer just about relying on the location or newness of a project to determine value. Instead of ‘flight for new,' we now face ‘flight for the new normal’ as space users place more value on COVID-19-conscious features and amenities. The need to reconsider building designs and configurations and the ability to adapt to the new normal has heavily impacted real estate investment decisions just as much as development.”

From what tenants will be looking for from their workspaces during and after the pandemic to how building owners can stay competitive in uncertain times, Freedman shared his insight and predictions for the future of the real estate market.

What are the most important building features tenants will prioritize moving forward amid the pandemic?

I think there are two categories — there is the building itself, and there are the tenant requirements which will evolve for individual companies and spaces. Everyone likes to talk about this topic at a macro, one-size-fits-all level, but the reality is that every business, depending on its nature of work, is going to be different in terms of what its post-COVID plan is.

That can be in terms of how to break out workers that are going to be on site in the office, those that will be working remotely full time and those that will have some kind of hybrid setup.

On the tenant side, we do know and expect that open floor plans are going to be more prevalent. The spacing out of employees has been cut in half over the last decade when it comes to the amount of square footage allocated per employee. There is going to be a reversion of that trend where the cubicles are going to get bigger, not smaller, and there will be more breakout rooms. Space requirements per employee will really vary from company to company as they figure out if they need more or less space than before. You may have fewer employees coming to work in person, but will need to spread them out more. Time will tell there.

When it comes to health-conscious items and building systems, more buildings will incorporate touchless entries to buildings, suites and elevators. Building managers will assign elevators to specific floors or install elevator systems that do so, install glass dividers in common areas and improve air filtration so it circulates through individual suites instead of entire buildings or floors. They will provide hand sanitizer stations throughout the building and take more of an overall approach to the health and wellness of people coming in and out of the building. There will be more of an emphasis on lighting, air quality and outdoor areas. As a result of that we think there’s going to be a flight to new.

What do you mean by a ‘flight to new’?

The older, existing 40- and 50-year-old buildings just can’t adapt [to incorporate COVID-19-era features like the ones we’ve just talked about, especially structural ones]. In order to adapt that kind of building, they would need to shut down completely, stop operations and retrofit the entire building. Therefore, we think that in the office space environment the “winners” are going to be the newer product that caters to [these trends and new tenant demand] or easily adapts and incorporates them, and that the “losers” are going to be the older buildings that cannot.

Do older, existing buildings have an opportunity to compete with newer construction?

In terms of quality of life features like natural light, ceiling heights, and open-air environments or column placements in the floor plan to create more open space, the answer is, “not really.” Can an older building change and retrofit to touchless pass-through elevator systems by spending several million dollars? Sure, you can do anything with enough money, but there are also certain fundamental things that you won’t be able to change unless you tear down the building, like changing the floor plate or adding floor-to-ceiling glass windows. Older buildings could improve their indoor air quality with better filtration, higher-quality filters, and by pumping in fresh outdoor air, which will be an important building amenity going forward.

How are you incorporating these "new normal" features into your current development projects?

I'll use one of our current projects in Fort Lauderdale as an example, which is now in the design phase. We bought a three-acre assemblage, and the site will have a 300,000-square-foot office tower with a second residential building and retail at ground level. We are already designing the office building with the intention of incorporating enhanced air filtration with very efficient coolers, and health-conscious features. We were leaning towards installing passenger elevator systems where you select your floor on a central monitor and the technology tells you which elevator to take, so you don't have to touch anything when you get in. Due to COVID-19, we are now researching enhanced technologies that would allow all entry doors to be touchless. The building will have 14-foot-clear ceiling heights, and we are now really aware of column and support beam placement in the floor plates. When we lay sample floor plans, we are now thinking, "the columns being placed here might be really challenging in this new [COVID-19] environment because it will force [a tenant to arrange their layout] in a tighter space between these columns," so we are being mindful of that in the design to allow for more space per employee.

How will the emphasis on location impact companies’ leasing decisions? Do you think location will be more or less of a decision-making factor in the future?

It’s a great question, and part of the answer goes back to being company-specific. I think the migration out of big cities is temporary to some extent — places like Boston, New York, or San Francisco are not going away and the notion that they might seems far-fetched to [our firm].

We have seen remote working work well and some people are more productive, but some aren’t. So our general consensus [as a company] is that remote working on an interim basis has proven that it can work, but it is not a permanent solution by any means, and a lot of great ideas, collaboration, and building of company culture happens, often unplanned, in person — not over Zoom. We think that once companies figure out which employees and teams need to be working in person regularly, and which ones only need to come in for critical meetings because maybe they get more done when they’re not commuting from the suburbs, you’ll see some “de-campusing”. For example, instead of one company having a 100,000-square-foot office, they might take 60,000 square feet in the city and have some smaller, 20,000-square-foot locations scattered across other towns where they have numerous employees. It will depend on what works for each company and business.

Even some of the leading and largest companies, like Twitter, Facebook and Google, for example, have said everyone can work from home through 2021, but at the same time they are expanding their office footprints and signing new leases in major cities. They know that people need to be together and that they get tired of being alone or get distracted by things in their homes. I think that the smart long-run bet is that while they may look different than they did before, offices are not going anywhere.

What are the features you look for when you’re evaluating an existing property for investment?

When buying existing product, we take into account where the world is today and where we believe it’s going. Geography is important, and we have seen a migration over the past decade from top-tier markets like California metros or New York, to secondary markets like cities in Texas, Tennessee and Florida, for example. That’s gone into turbocharge now as people leave the city during the pandemic.

But when we talk about “winners and losers,” it’s not as simple as just saying New York or Miami will do well or not. Its about the requirements of the people moving there and what they’ll be looking for from a living and working standpoint and what types of spaces they will gravitate toward. Will the building be able to incorporate the “new-normal” features and trends, like column-free floor plans, ample natural light, and health and wellness features that respond to the pandemic?

For example, we are long-term bullish on new, quality South Florida offices, and we are bearish on old, inefficient existing office product. Now, those could each exist on the same block. It’s very similar to a pair trade in the stock market where you have stocks in the same asset class and industry, but you’re going long on one and short on the other, and that’s what is happening in the real estate market right now. It’s honestly the first time in a long time, at least in my experience, that there has been such a binary dynamic.

What trends and impacts are you seeing in other sectors of real estate?

Retail. The retail landscape was changing and suffering before COVID-19, and coronavirus dealt a fatal blow. The allure to walking into a department store is not really appealing to a lot of people anymore, and that started from the advent of Amazon and the like, and now on top of this, people want to avoid crowds because of COVID-19. That being said, real estate has always been able to reinvent itself. Remember Blockbuster video stores? Those went out of business and that real estate became something else. We’ve seen it with shopping malls and big box stores that have been repurposed into coworking space or fitness and health spaces. So, I think we’ll see an acceleration of repurposing retail because there is going to be a lot of vacant retail space.

[Our company] still believes in high-street urban retail where there’s a massive body count and heavy foot traffic at the location, whether it’s near mass transit or a busy downtown hub. It might change hands and rents will get adjusted, but that real estate retail experience will endure even if it looks different.

Multifamily. With multifamily we have seen investors retreat to safety, which right now means [purchasing] multifamily and industrial assets. That’s where capital has gone because interest rates are heading lower and it’s the only asset where investors feel they can get yield safely, and I think there is good indication that will continue. Multifamily and industrial [buildings] are assets within real estate that have had relatively low impact from COVID-19 and are seen as safe from future pandemics, especially over hard-hit sectors like hotels, retail and office, which are becoming distressed assets.

I think that new, ground-up development of multifamily is going to incorporate in-unit, built-in office or work-from-home nooks. However, I don’t think the pandemic will create a mass exodus out of existing multifamily stock. The multifamily sector is holding up relatively well overall, and on a macro level, multifamily is going to endure.

This interview has been edited for clarity.