Friday, June 14, 2024

Nick Millican Discusses Mean Reversion in a 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 isn’t so pessimistic. There are challenges ahead, to be sure, he says. But real estate over the long term is always a good bet.

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

Mean reversion is a theory which holds that asset price volatility and historical returns will eventually revert over the long run to an average level of a dataset. In short, says Millican, commercial real estate will typically always grow — especially from a position when assets are priced below their value, which has been the case with commercial real estate for the past few years.

That’s not to say that there won’t be hurdles along the way. As well as its tremendous effects on health and society, the COVID pandemic has had a seismic impact on not only the economy generally, but commercial real estate specifically, Millican admits.

There Has Been a Change — but There Will Be Another

How we view and use office space has changed dramatically in the past few years. During the pandemic, the workforce en masse was forced out of its places of business. As people began going back to the office in subsequent years, they returned with completely different views than the ones they commonly held in 2019. No longer did office attendance seem compulsory. No longer did commuting for hours every week seem like something you had to do. As a result, employees became more discerning about their place of employment and developed a lower tolerance for low-quality offices. As a result, businesses have had to entirely rethink their office space.

“In the years leading up to the 2020 global pandemic, for a long time office space was seen by a lot of mainstream corporate clients as a cost centre where their real estate team’s job was to lower the cost per desk and drive efficiency out of it,” explained Millican. “And so you ended up with office workers being crammed into very dense open-plan space — typically, not great-quality offices.”

For employees, such space is no longer attractive. And since they increasingly have the choice to work from home (if their current employer doesn’t offer it, employees are now more likely to simply leave), businesses have had to adapt. So, too, have the commercial real estate providers offering office space to prospective tenants, says Millican.

“There’s been a fairly vociferous reaction against many of the old office space criteria because it’s hard enough to get people to come back to the office,” says Nick Millican. “I don’t think we will ever get back to exactly the way things were in 2019. One of the things that the pandemic has made employers do is think, ‘If we are going to drag our staff 45 minutes away from their house to come and work, then we have to do a better job of making that place somewhere they’d like to be.’”

But while these issues may continue to be a sticking point for commercial real estate providers, Millican thinks that over the long term, the future still looks bright for the sector. Even over the short and medium terms, Nick Millican sees these challenges not as brick walls, but as hurdles that can be overcome by smart operators who can differentiate themselves in the marketplace.

Why Real Estate Grows in Value Over the Long Term

As an asset, real estate, over the long term has always been a good bet. Given a long enough time frame, the growth and value curve for commercial real estate always heads upward, says Nick Millican. 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’s widely used in many financial time series datasets, including price, earnings, and book value. The idea, Millican explains, is that when an asset’s current market price is less than its average past price, it’s considered an attractive asset to purchase. Conversely, if the current price of an asset is above the average, it’s expected to fall. In the stock market, traders and investors use mean reversion as a way to help them time their trading and investment strategies.

Mean reversion, says Millican, suggests that current asset prices and volatility of commercial real estate will eventually revert to their long-term average levels. And those long-term average levels have an upward growth trajectory.

Confident of the Future, Nick Millican Is Still Mindful of the Present

It’s true, however, says Millican, that 2023 has proved itself a formidable year for investing in commercial real estate. In the U.K., Europe, and the U.S. in particular, the market has been struggling with factors, including low levels of demand, low occupation rates, concerns about the future, and the influence of high-interest rates.

In the second quarter of 2023, the sector saw a slowdown in leasing velocity in certain sectors. In the U.S., bank failures such as Silicon Valley Bank and the First Republic created a sense of unease in the market since many commercial real estate providers in that sector rely on small banks for capital. This situation led to speculation about the future direction of commercial real estate.

Yet professionals like Nick Millican note that some market analysts are predicting that the commercial property market will recover in 2024 as a lack of development supply, the move toward sustainable buildings, and the reopening of the Chinese economy will support activity, even as working habits remain shaken up by the pandemic.

The path ahead for savvy real estate operators, says Millican, is to offer tenants and prospects the types of properties they want now and in the future.

For Nick Millican, that means higher-quality office spaces in popular business centres. It means focusing on providing collaborative space for team meetings, rather than rows of unattractive cubicles.

“I predict there will be less of the suburban office parks,” he says. “But the offices within city centres should survive.”

Claire James
Claire James
Claire is an accounts manager at Fire Digital UK, an online publishing and content marketing company based in the North West.

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