Nick Millikan discusses mean reversion in the post-COVID era

Where to next for commercial real estate? While some commentators are spinning tales of gloom and doom, commercial real estate professional Nick Millican is not so pessimistic. Certainly, there are challenges ahead, he says. But real estate is always a good bet in the long run.

While many market analysts and economic commentators focus on the near term – looking barely a quarter ahead in their forecasts – Millikan takes a different approach. He looks towards the long term. And when you look long term, the future of commercial real estate is bright, he predicts – thanks to mean reversion.

Mean reversion is a theory that holds that asset price volatility and historical returns will eventually return to the average level of a dataset in the long run. In short, Millikan says, commercial real estate will generally always rise — especially when properties are priced below their value, which has been the case for commercial real estate for the past few years.

This doesn’t mean there won’t be obstacles along the way. Millikan believes that in addition to its tremendous impacts on health and society, the COVID pandemic has had a seismic impact not only on the economy in general, but on commercial real estate in particular.

There has been a change – but there will be another

How we view and use office space has changed dramatically over the last few years. During the pandemic, the workforce was collectively forced to move out of their places of business. As people began to head back to the office in later years, they returned with completely different ideas than what we typically saw in 2019. Now office attendance does not seem mandatory. Now commuting for hours every week doesn’t seem like something you have to do. As a result, employees became more discerning about their place of employment and developed less tolerance for low-quality offices. As a result, businesses have had to completely rethink their office space.

“In the years before the 2020 global pandemic, office space was long viewed by many mainstream corporate clients as a cost center, where the job of their real estate team was to reduce costs per desk and thereby increase efficiency . ,” Millikan explained. “And so you end up cramming office workers into very dense open-plan spaces – typically, not good quality offices.”

Such a place is no longer attractive for employees. And as they increasingly have the option to work from home (employees are now more likely to simply leave if their current employer doesn’t offer it), businesses have had to adapt. Commercial real estate providers are also offering office space to potential tenants, Millikan says.

“There has been quite a vocal reaction against many of the old office space norms because it is quite difficult to get people back into the office,” says Nick Millikan. “I don’t think we’ll ever get back to exactly the way things were in 2019. One of the things the pandemic has forced employers to do is think, ‘If we can get our employees 45 minutes from their home, “Come and work, then we’ve got to do a better job of making that place a place where they want to live.”

But while these issues may remain a hurdle for commercial real estate providers, Millican believes that in the long term, the future still looks bright for the sector. Even in the short and medium term, Nick Millikan sees these challenges not as brick walls, but as obstacles that can be overcome by smart operators who can differentiate themselves in the marketplace.

Why does the value of real estate increase in the long term?

As an asset, real estate has always been a good bet in the long run. Nick Millikan says that given a long enough time frame, the growth and value curve for commercial real estate always moves upward. Commercial real estate is one of the best case studies of mean reversion for any investable market.

The concept of mean reversion is one that is widely used in many financial time series datasets, including price, earnings and book value. Thoughts, Millikan telling, that is, when the current market price of a property is lower than its previous average price, it is considered an attractive property to buy. Conversely, if the current price of an asset is above the average, it is expected to fall. In the stock market, traders and investors use mean reversion to help them time their trading and investing strategies.

Millikan says mean reversion shows that current asset prices and commercial real estate volatility will eventually return to their long-term average levels. And those long-term average levels have an upward growth trajectory.

Confident of the future, Nick Millikan is still mindful of the present

However, Millikan says it is true that 2023 is proving to be a difficult year for investing in commercial real estate. In the UK, Europe and particularly the US, the market is struggling with factors including low demand levels, low business rates, concerns about the future and the impact of high-interest rates.

In the second quarter of 2023, the region saw a slowdown in leasing velocity in some areas. In the US, bank failures such as Silicon Valley Bank and First Republic created a sense of unease in the market as many commercial real estate providers in that region rely on smaller banks for capital. This situation led to speculation about the future direction of commercial real estate.

Yet professionals such as Nick Millikan say some market analysts are predicting that the commercial property market will see growth in 2024 supported by activity driven by a supply shortage, the move towards sustainable buildings and the reopening of the Chinese economy, even if working habits change. Stay tuned. Shaken by the pandemic.

Millikan says the way forward for savvy real estate operators is to offer tenants and prospects the properties they want now and in the future.

For Nick Millikan, this means high quality office space in popular business centres. This means focusing on providing collaborative space for team meetings rather than rows of unattractive cubicles.

“My prediction is that there will be fewer suburban office parks,” he says, “but offices within city centers should survive.”