The Existential Threat Facing the Office

A number of fundamental changes that have been looming for some time have begun to hit the headlines in the last week or so. 

The first involves fundamental changes in parts of the property market. Then there’s the real possibility of ingrained long-term inflation and interest rates as a result of the conversion to renewable power and, finally, the gymnastics on Wall Street which will have us on the edge of our seats for some time. 

Fundamental Changes

In the property sector, all the signs are that the fall in the value of office blocks is only partly related to interest rates and the economic slowdown. It is much more about a fundamental change in the community.

Enterprises and governments are finding it very difficult to get people to come back to city offices to work. Large numbers have adjusted their lifestyle to remote living and therefore flexible working.

For many, long commutes take up a big portion of the day.

Of course, many occupations require attendance at a particular place each day, but office work does not. This has been looming for some time but it was assumed by institutional office tower owners that once COVID was over it would be back to “normal”. Clearly, around the world, it is not happening.

Second-grade office blocks and even some first-grade ones are going to suffer a fall in value that goes well beyond market forces because there is a big surplus of space. Many of the offices will be pulled down or renovated and replaced with apartments. In some cities in the US, inner city wastelands have developed which are dangerous.

If you are invested in a non-self-managed superannuation fund with a large exposure to office property you would have almost certainly seen the property decline in value. But be wary of small write downs because they probably indicate that there is more to come.

We saw an unlisted Charter Hall Fund offer its subscribers a once in a five-year opportunity to liquidate their assets and about 20 per cent took that opportunity. That meant substantial sales of office buildings and the price levels achieved in those sales over the next six months or so will determine the real value of office property going forward. 

If your non-self-managed superannuation fund gives you flexibility to swap asset classes and the write downs have not been substantial, then switch to a different area of investing.

But there is a sidebar to the decision of workers to work from home. If the current decline gathers momentum and there is a rise in unemployment, then enterprises and governments may be able force more of their workers back.

The great problem with working from home is that the enterprise itself can’t easily train new people. Boards of large companies are very worried about this and will need to devise better training systems to overcome the problem.

Build-to-Rent

At the other end of the spectrum, there are signs that the recovery in dwellings is slowing down. The rental market is currently dominated by families who own one or two rental properties. They are finding the task of managing their tenants and properties harder and harder and this has contributed to many deciding to sell and investing in other areas. Most of these properties are being bought by owner-occupiers which is part of the reason why rents have risen.

I believe that this shortage of housing and strong rental market is going to help the development of a new asset class – building apartments for rent. It is a lot more efficient to manage tenants in a block of apartments than it is in a single dwelling. The renters can amortise the cost of complying with regulations and managing tenants on a larger scale which enables expertise to be recruited.

We are already seeing some overseas superannuation funds invest in this area and I think we are going to see a lot more. The big Australian superannuation funds have been slow partly because they are caught in office buildings.

Carbon and Inflation

When it comes to inflation, the standard central bank argument is that if they depress the economy, boost unemployment and reduce demand prices will stabilise or reduce. Over the decades that process has been harsh, but it has worked. But this time round we have a very dangerous situation – we are converting from carbon-based energy sources to non-carbon.

In the jungle of remarks that are associated with this change, the proponents of renewable energy say it is much cheaper and, of course, in theory, they are right, because the cost of operating, say, wind and solar are very low. 

But in fact, this is a false argument. 

The wind farms and solar panels and transmission lines and all the other infrastructure requirements involved in renewables require massive capital investment (including mining investment). This investment will require a return. In Australia we are looking at investment of about $1.5 trillion– that figure might be too high, but it is going to be very high. 

Moreover, massive investment is being repeated in Europe and the US and other parts of the world. It is going inflate the cost of minerals plus equipment and require enormous amounts of capital. The costs involved in servicing that capital will require much higher power prices than exist today if we continue with the current strategies. We need to develop better strategies that are less capital intensive. 

In particular, the cost of wind generators is rising strongly because of demand around the world. But wind generators only last about 30 years so, unlike a major hydro project like the Snowy which can last up to 100 years, they are a very expensive investment.

The bottom line is that there will be huge demands in capital and the rising prices in electricity underpinning longer term inflation rates. It doesn’t mean inflation will skyrocket out of control, but it does mean that it will be very difficult to return to rates of 2 and 3 per cent. 

New Tech Frontier

Finally, on Wall Street once again the punters are having a ball pushing up the value of high technology companies which they see as a new frontier. 

I am always dubious about investment fads where all too often excitement overtakes reality. But on the other side there is a growing group of people who have been shorting in the American markets.

The rises in the indexes mainly driven by high technology giants is causing the shorters to suffer considerable paper losses. If the shorters’ dam bursts and they begin to liquidate their positions (which means buying back the stock that is shorted) it will create a big upward spike on Wall Street.

So, we have two opposite forces. I don’t know the end result but there is a deadly game being played.