The ways in which the US economy - post-Covid - has evolved with its new flaws, difficulties, and, of course, opportunities has seen an enormous amount of strategic decisions needing to be made to keep up.
This is especially the case with new working from home patterns and other factors that have massively changed the commercial real estate (CRE) sector as an investment opportunity.
Once upon a time CRE was the blue-chip asset of a portfolio, but post-Covid the asset class is a minefield of hits and misses.
How investment teams at insurers should overcome these issues and learn to deal with the new reality was part of a discussion at the Insurance Investor Live | Midwest event in Chicago earlier this year, which is now part of the Insurance Asset Management Mid-Year Insights report.
In the conversation, Greg Cobb, Director of Insurance Solutions, Sage Advisory Services discussed with representatives from Swiss Re, Shelter Insurance, and PPM America about what changes they were seeing.
"When you have a very tight labour market, employers are more generous with benefits, working from home being one of them."
One of the talking points was whether, from a macro standpoint, the current US labour market conditions would stick around as well what it meant for the recent changes to the real estate sector.
“The interesting factor is that when you have a very tight labour market, employers are typically much more generous with benefits, working from home being one of them,” said Mahir Rasheed, Vice President, Senior Economist, Swiss Re. “But it seems as though when you look at some of the higher frequency labour market data that we have gotten recently, employers are starting to be a bit stricter and stern with these types of flexible arrangements.”
He added that his own company was in a similar situation of expensive inner-city offices and suburban satellite locations and not knowing which to keep. “The Swiss Re office in Manhattan is packed and we are in the office most days of the week, but we have a campus in [Westchester County, New York] and there aren’t that many people there at all so these are conversations that we are having internally about diversification.”
He added that changes in the labour market around working from home and office usage are going to depend on how much weakening the market sees over the next couple of years as the ‘great resignation’ fades from memory (despite still being around) and the labour shortages cool off. “Employers were a bit more constrained when they were fighting for quality labour and if that changes over the next six-to-12 months then clearly there would be a lot more pressure on greater occupancy in the offices,” he said.
Matt Pitzer, Director, Private Markets, Shelter Insurance, was largely in agreement with Rasheed and added that the market had changed, especially when it came to the massive oversupply of offices in parts of the US, and that a lot of work was needed to make current stock fit the demand. “If we look forward to the best buildings that can handle the current debt service there are some opportunities but there are just too many B and C class buildings that need to be taken off the market and converted to some other use so that we can right-size the supply and demand in most cities,” he said.
“In the US, we all went through a period of denial after Covid where it was about waiting long enough, [and then] people would come back into the office and that capacity would be taken up,” he said. Some statistics have said that companies are now leasing less office space and that the next cycle of leasing agreements are still yet to be renegotiated by companies, which means this trend could continue for several years yet.
“From my company’s perspective, we are a typical sleepy midwestern mutual insurance company. We have a growing headcount of 1-2% per year and plod along at that rate,” said Pitzer. “We got to a point in 2018 where we were physically out of space in our main headquarters building and so went through a corporate planning process and decided that we needed to build a second building on our campus because we were going to continue this slow growth of head count and people need a place to work.”
Pitzer gave the example of his own company breaking ground in the summer of 2019 on a new building on its campus, which they completed a couple of years later, as an issue for the larger market as what to do with the excess of office space. “We put [our build] on hold for a while but completed it because we had a hole in the ground. Now we have two half empty buildings on our campus. We own it and will own it forever, but I don’t feel that this is atypical for what a lot of people are going through,” he said.
"My diversified portfolio is 80% multi-family and industrial, which doesn’t feel
all that diversified, and I am trying to figure out where else I can go."
This could mean a lot of stranded assets going forward as investors struggle to offload the excess, which, if they can’t repurpose them, drop in value.
Pitzer said this changed the company's investment outlook, from an equity perspective, and that it changed how they think about their diversified real estate exposure. “You used to count on that office allocation as the core part of your core portfolio, there were cycles up and down, but it eventually worked itself out,” he said. “Now, my diversified portfolio is 80% multi-family and industrial, which doesn’t feel all that diversified, and I am trying to figure out where else I can go to deploy meaningful dollars and get more diversified sector exposure. This is something that every real estate investor is going through.”
