Elgin Area Chamber Of Commerce: Sam Zell Says Normal Office Usage Will Return In A Couple Of Years, But Sector Still Faces 'Massive

Press release from the Elgin Area Chamber of Commerce:

October 15, 2021

By Tony Wilbert
CoStar News
 

Real estate magnate Sam Zell said he expects normal office usage to return within a couple of years as companies realize the importance of in-person interaction at work, but he warned that the sector is facing an incredibly large oversupply of space.
 

While the pandemic required a temporary switch to having employees work from home when the global health crisis emerged, companies that have decided to allow employees to work remotely for long periods will suffer in the long run, Zell said.

"I think work from home is an interesting necessity during a pandemic but is not the way you build profits, not the way you build community, not the way you build achievements, not the way you intelligently evaluate people and their contributions," he said during an interview with CoStar Group CEO Andy Florance. CoStar Group, publisher of CoStar News, sponsored the online discussion Thursday as part of the Industry Talk series by Virginia Commonwealth University's Kornblau Real Estate Program.

"I think that over a relatively short period of time, a couple of years, you’re going to see basically a return to quote normal in terms of office building usage," Zell said.

Sam Zell (left) and CoStar Group CEO Andy Florance chat online as part of the Industry Talk series by Virginia Commonwealth University's Kornblau Real Estate Program. (Virginia Commonwealth University)

Zell is widely regarded as one of the country's most astute investors, especially in industries and companies in distress. He sold Equity Office Properties, what was the largest office owner in the U.S., to Blackstone for $36 billion in 2007 in what was then the biggest deal of its kind. Zell's timing proved prescient as the Great Recession started in December 2007 and hit the U.S. office market especially hard.

Office space plays a key role in creating the right work environment and company culture, said Zell, chairman of Chicago-based Equity Group Investments. He said he was the only one to work out of his company office when the pandemic began and for four months after that.

"How do you motivate by modem?" Zell said. "How do you basically assess the quality of people? How do you create an environment where, you know, you all of a sudden remember something and you step inside to the next office and say, ‘By the way, da da da da da.’ "That’s the watercooler story, but I think that’s a very important part. We’re social animals. We’ve succeeded by being together and creating one plus one equals three."

However, as workers return, office landlords have a larger hurdle to clear because there's too much supply and too many obsolete properties, Zell said. "My own view is that the office market was massively oversupplied before the pandemic, that the creation of the companies like WeWork and other companies that basically created the appearance that they were quote 'creating occupancy' for five years from now," he said. "So all of a sudden, the statistics started saying, ‘Gee, we’re going to have a shortage,’ and everybody used those statistics to create supply.

"And what we got today is a good old-fashioned massive oversupply, and I think it’s going to take a number of years" to work through. Although office leasing activity improved in the second and third quarters, an influx of new supply and large amount of space available for sublease is likely to push the national vacancy rate higher over the next few quarters, CoStar director of market analytics David Kahn said.

Overall office vacancy in the U.S. stood at less than 10% before the pandemic started in March 2020, according to CoStar data. The country's vacancy rate jumped to more than 12% this week and is projected to climb to more than 13% by 2023 before stabilizing.

The emergence of environmental, social and corporate governance efforts in large corporations could end up playing a role in sorting out what properties prove most valuable, as companies seek sustainable office space that has less impact on the environment, Zell said.

"I think all this ESG stuff, green buildings may end up being the methodology of separating the wheat from the chaff," Zell said. "But the net effect is, we have too much space, an enormous amount of obsolete office space, and I don’t know what it can be converted to."

As an investor who has bought distressed properties in the past, Zell demurred on whether he would be a buyer now. "I think there will be a collection of distressed assets, but you have to have an opinion as to what you’re going to do with those distressed assets," Zell said.

"And I think the challenge is going to be that there is going to be a lot of distressed assets and no clear direction as to how to recover the value," he said.

As for other investment opportunities that could emerge, especially as inflation rises in the U.S., Zell seemed to agree with Mark Twain's philosophy to "Buy land, they're not making it anymore."
"I think that particularly in real estate, I think that value comes from land," Zell said. "Land is basically the ultimate accordion. When you look at, you know, a real estate project, it costs so much [to build] per square foot. Some cost more a square foot, some less a square foot, but it’s basically the land that’s the scarcity."

Moreover, Zell said smart investors, developers and corporations need to anticipate the impact of the rising costs of goods and products on their investments.

"In an inflationary environment, costs are permeated throughout the system. And, in a way, you know the separation of the men from the boys tends to be those companies that are able to prognosticate what their costs are going to be and make sure that their pricing is constantly in line with their cost structure," Zell said. "Because, in effect, in the end it’s all about margin, even in real estate."

Source: CoStar Group, www.costar.com

This press release was produced by the Elgin Area Chamber of Commerce. The views expressed here are the author’s own.