Play the Return-to-Office Trade with an Office REIT ETF

The pandemic has been a watershed moment for many industries, but perhaps none more so than the office space and commercial real estate sectors. As the world grappled with lockdowns and health concerns, the very concept of a traditional office underwent a seismic shift. The rapid adoption and persistence of the work-from-home trend have left marks on the commercial real estate landscape. However, as with most market disruptions, there are usually two sides to the coin. While the immediate outlook might seem bleak, there may also be potential for opportunity for investors in office REITs.

What are Office REITs?

Real Estate Investment Trusts (REITs) are companies that invest in all aspects of real estate, and office REITs are those that specialize in office properties. Those properties can range from skyscrapers to office parks, allowing individual investors to tap into large-scale office real estate markets without direct property ownership. REITs offer the dual benefit of capital appreciation and regular dividend income, as they are mandated by law to distribute a significant portion of their earnings to shareholders. This structure provides an approach for those looking to gain exposure to the office real estate market without the challenges of owning property directly.

Changing Currents in Office Real Estate

The pandemic forced businesses to prioritize the safety of their employees, leading to an unprecedented surge in the adoption of the work-from-home model. Companies that had never considered remote work viable were suddenly thrust into a situation where it was the only option. Tools like Zoom and Microsoft Teams became household names overnight, and technology giants like Twitter and Facebook were among the first to announce work-from-home policies, setting a trend that many others followed.

This shift had a cascading effect on the office property sector. The immediate consequence of this shift was reduced demand for office spaces. Companies started to re-evaluate their needs, leading to a decline in lease renewals and even the termination of existing leases. Vacancy rates in prime office locations soared, and rental prices plummeted, leading to a decline in property values. Today, the valuations for U.S. office properties remain depressed and vacancy rates stand at a record high of 13.1%, as of the end of last quarter, up from a pre-pandemic 9.4% in Q2 2019, according to the National Association of Realtors¹. This burden can be seen in the poor performance of U.S. office property REITs in recent years.

U.S. Office REITs in Decline | January 2018 – August 2023

Source: Morningstar, 8/31/2023. Past performance is no guarantee of future results. Not intended as a recommendation to buy or to sell any of the securities mentioned herein.

However, while uncertainty in office space real estate remains, signs are emerging that the work-from-home trend is starting to reverse. Many of the largest U.S. companies, including Amazon, BlackRock, and JPMorgan, are now requiring employees to return to the office full or part-time. Even Zoom, the company that powered the remote work revolution during the pandemic, is asking its employees to come back to the office. It is clear that businesses still recognize the importance of physical office spaces for fostering collaboration, creativity, and corporate culture. This emerging return-to-office trend could be an indication that the tides are changing for office space, creating a potential investment opportunity for those with a long-term perspective.

Retail's Resilient Return

The ripple effects of the pandemic have not been limited to just office property; other commercial real estate sectors were significantly impacted as well, notably retail. The retail sector, already grappling with challenges from e-commerce giants, faced further strain as lockdowns and social distancing norms took hold. Many brick-and-mortar stores, especially those without a strong online presence, struggled to stay afloat, leading to increased vacancies in prime retail locations.

However, retail real estate has since bounced back and is surprisingly enjoying its biggest revival in years. Retailers are on track to open 1,000 net new stores in the U.S. this year as retail availability hits record lows². Demand for retail space has remained robust this year, defying inflation pressures and high interest rates. In fact, the retail property segment currently has the lowest vacancy rate among all commercial real estate sectors at 4.2% as of the end of last quarter¹.

While some of this strength in vacancy is partially the result of reduced retail construction following the 2008-09 financial crisis, much of the rush for retail space can also be attributed to healthy consumer demand and failed predictions that internet sales would wipe out physical retail locations. Some digitally native companies are even beginning to open brick-and-mortar locations to expand customer acquisition beyond online-only avenues. More so, this demand for retail space is expected to remain robust according to the latest commercial real estate research from the National Association of Realtors¹.

VanEck Office and Commercial REIT ETF

While office properties, and commercial real estate more broadly, have undoubtedly faced challenges due to the pandemic and the shift to remote work, it's crucial to view these challenges in the broader context of market cycles and long-term trends. For the discerning investor, the current situation might just be the contrarian opportunity they've been waiting for.

For investors looking to gain exposure to this segment of the real estate market, the VanEck Office and Commercial REIT ETF (DESK) can be an efficient vehicle to do so. DESK seeks to track the MarketVector US Listed Office and Commercial REITs Index, which tracks the overall performance of U.S. exchange-listed REITs operating in the office and commercial real estate markets, and can be used to express a view on the future of office properties in a single trade.

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