- By April 2021, office-focused listed real estate companies became the worst-performing segment in the MSCI World Core IMI Real Estate Index, on a cumulative basis since January 2020.
- Office’s relatively poor recent performance upset the pattern of returns — across regions and public and private markets — seen in 2020, when industrial outperformed, retail and hotels lagged and office and residential had middling returns.
- Private-market data has not shown such a shift in sector-performance rankings but, looking deeper, we can see the performance of office assets has varied by location type and lease structure.
COVID-19 disrupted real estate across countries and property segments. The biggest initial impacts were felt in retail, leisure and hotels, which were most directly exposed to social distancing and lockdowns. But more recently, the performance of listed offices has lagged. This has not yet been seen in private-market data, since it takes much longer for such trends to be reflected in private-asset valuations.
The shift to “work from home” since the pandemic started accounts for some of the listed office sector’s recent relative performance woes, as speculation about future office demand has weighed on sentiment and hence stock prices.1 In this blog post, we delve into the bewildering array of public- and private-market data on office property’s returns.
On Listed Markets, Offices Fell Behind All Other Segments
Since Jan. 30, 2020, when the World Health Organization declared the COVID-19 outbreak to be a global health emergency, to April 26, 2021, office-focused listed real estate companies were the worst-performing property type in the MSCI World Core IMI Real Estate Index on a cumulative basis.
During this time, the segment’s returns fell by 13.0% — lower than both retail (at -11.2%) and hotels and resorts (-5.9%). Through most of 2020, listed companies with a focus on the office sector had trended above these segments — a trend mirrored in private-asset data. In November 2020, however, a shift took place in listed markets, where news of potential COVID vaccines coincided with a strong rebound in listed real estate. While retail- and hotel-focused companies bounced back and have since grown more strongly, office companies lagged, as can be seen in the exhibit below.
Listed Hotel and Retail Recovered More than Office from Pandemic Lows
Negative Sentiment on Offices Not as Obvious in Private Data
The story has been less dramatic in the data on private real estate. Private-asset office property’s performance largely mirrored that of public markets for the bulk of 2020, although it was more muted. Since January 2020, there has been a consistent picture across geographies, both in public- and private-market data: Industrial clearly outperformed, retail and hotel property lagged and office and residential delivered middling returns. The exhibit below shows how office returns compared to other property sectors across national private-asset indexes in 2020.
Offices outperformed retail property in 23 of 24 markets and underperformed industrial in 22 of 24 markets. Only three office markets recorded a negative total return in 2020: Canada (-1.5%), the U.K. (-1.6%) and South Africa (-1.8%). Indeed, 10 of 24 markets reported positive capital growth in 2020, and in the 10 markets where offices underperformed industrial, offices had stronger growth in net operating income.
Private-Market Office Outperformed Retail in All But One Market in 2020
Source: MSCI Global Intel
Taking a deeper look at the U.S., we can see that central-business-district (CBD) offices, the best-performing office segment over the last five and 10 years, underperformed versus more decentralized locations since the start of 2020. CBD office is the only U.S. office segment with returns still in negative territory after the initial hit in June 2020.
In the US, City-Center Offices Lagged the Most amid COVID
Source: MSCI Global Intel
Lease Length Mattered Too
Property type and geography can explain only so much of property returns’ variation. Other factors such as lease length can help explain relative performance of real estate assets. For example, during rising markets, properties with shorter lease expiry benefited from growing market rents while the opposite was true in a weakening market.
In 2020, longer-leased office assets across the globe outperformed as income security was increasingly valued in an uncertain operating environment. In the U.K., office properties with a remaining lease term in the upper quartile for length recorded a total return of 4.9% for 2020, while the return of those in the lower quartile was -4.0% — a spread of 8.9%. Longer-leased offices also outperformed in the U.S. (a spread of 3.8%), continental Europe (2.1%) and Ireland (0.9%). The more significant impact of lease length in the U.K. may be explained by the greater difference in length between the longest and shortest leases when compared to other countries.2
Longer Leases Have Buoyed Some Office Returns
Source: MSCI Real Estate
Seeking Greater Insight Across Public- and Private-Market Data
In listed markets, offices now appear to be bearing the brunt of investors’ negative sentiment, while segments such as retail, hotel and leisure are recovering more strongly. Private-asset data for 2020 hasn’t shown a significant softening in office returns relative to other sectors, but there is evidence of an emerging differential found by looking at more frequent data points and varied segmentations. Close attention to the public- and private-market data may help investors manage their office portfolios in the face of so much uncertainty and potential disruption facing global office markets.
The author thanks Fritz Louw for his contribution to this blog post.
1"The rise of working from home." Economist, April 10, 2021.
2Analysis is based on a subset of lease-level data from each of the indexes. As a percentage of total leases, the subset amounted to 95% for the U.K. and Ireland, 56% for Europe ex UK and 27% for the U.S.