Could the pandemic-induced shift to remote work affect future real estate investment returns?

By Ed McCarthy

Canadian defined benefit plans own significant amounts of real estate. According to the Pension Investment Association of Canada’s 2019 Asset Mix Report, these plans had 12.09% of their assets in real estate as of Dec. 31, 2019.

Given the recent large-scale transition to remote work among office workers, could there be problems ahead for these plan’s investments? A recent Invesco white paper, “2020 Global Real Estate Report: Transformative Trends Canadian Pension Plans Need To Navigate Now,” evaluated the real estate market.

Office Vacancies

“The office sector is one of the sectors most affected by the pandemic,” said Michael Peck, senior vice president, institutional investments, Invesco, in an email interview. “Pre-pandemic there was already considerable debate about the future of the office sector. This has been compounded by COVID-19,” Peck explained.

The performance and outlook varied among office-space subsectors, however. There has been a clear pattern of outperformance for the most prime central business district (CBD) locations, particularly office submarkets in innovation/life science hubs, according to Peck.

Creative office buildings and sub-markets have been outperforming more traditional office buildings and locations, and this pattern is likely to continue after the pandemic, he said.

The success that firms have had transitioning to remote work could reduce overall demand for office space in the future, but Peck believes it’s likely to disproportionately affect more conventional buildings and locations.

Demand in other property niches, such as creative office buildings, especially in technology and life sciences, should remain resilient. These professions tend to value face-to-face interaction and collaboration for creativity and innovation.

Location Matters

On balance, the combination of these factors suggests that while overall demand for space might hold up, the willingness and ability of tenants to pay for it may be more of a challenge for investors if it is used less intensively, Peck cautions.

The best buildings in the best locations — with demand driven by tech and life science companies — appear to be better positioned than commodity buildings and locations that depend on tenants carrying out routine functions poised to become automated or done from home.

Location still matters, and large pension plans tend to globally diversify their real estate holdings. Sponsors should consider how demographics can influence a global strategy and evaluate regional trends and underlying sector factors, according to Invesco’s analysis.

“What underlying sectors — like residential, office, logistics and retail — are you getting exposure to through different geographies?” Peck asked in the report. “When it comes to supply-demand dynamics for real estate, Europe is quite different from Asia, which is also quite different from the U.S.”

Managing Risk

A plan’s investment philosophy determines the risk it accepts and how it manages that level of risk.

The following principles guide Invesco’s core real estate strategies globally and are applicable to pension plans’ investments:

  • Durable, growing income:Focus on quality assets and locations that can deliver durable, growing income which should also be relatively resilient in downturns;
  • Differentiated real estate: Focus on assets that are positioned to attract outsized demand in submarkets and/or have demonstrated enduring success over many years — or emerging submarkets that have the underlying characteristics to be successful;
  • Climate change and resilience: This has emerged in recent years as a key component of both asset and portfolio risk mitigation. Historically it was enough to identify and insure the risk.

Increasingly, it is important to build asset-level mitigation measures into buildings and limit the exposure to any one class of climate risk as part of an overall portfolio assessment.

Ed McCarthy is a longtime financial writer and author of three books, including “Foundations of Computational Finance with MATLAB.”