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Real estate

The moment of truth for office as workers begin their return

Paul Leonard
Director of Research, Real Estate, Americas
Leo Chung
Director of Research, Real Estate, Asia Pacific
Andy Schofield
Director of Research, Real Estate, Europe
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The moment of truth for office as workers begin their return

A greatly uneven pattern is unfolding globally as staff make their way back to the office. With data on office utilization hard to come by globally, non-traditional datasets can help shed light on how the return to the office is taking shape.

Google workplace mobility data, although distorted by non-office visits to the CBD such as leisure and shopping, provides a window on such re-engagement. Figure 1 contains spot data for the week ending May 1 for a selection of markets in each global region. In the United States, San Francisco is still 37% below its pre-pandemic activity, with the bigger conurbations ranging between 20% and 25% below the baseline. Trends across Asian cities are starker, with Seoul and Singapore back to normal, while Sydney lags at one-third below its pre-pandemic level. Meanwhile, in Europe, London office markets lag the rest of the continent at 31-34% below the baseline. Amsterdam and Paris are showing marginally better results, whilst Berlin is now just 10% below its pre-pandemic baseline.

Relative to pre-pandemic baseline

Bloomberg’s Pret a Manger Index, which monitors sandwich sales in selected global gateway cities, provides another clue. While imperfect, the index offers a useful weekly proxy of footfall. Figure 2 shows the spot results for the end of April. Sales in New York’s downtown or financial cluster (which includes Tribeca and Wall Street) have been slower to catch up compared with London’s financial districts (City and Docklands). Hong Kong, meanwhile, is clearly suffering from heavy restrictions on activity and remains the outlier, while Paris and London’s West End appear to be back to normal.

Pret sandwich sales relative to pre-pandemic base (=1)

Automobile traffic is still down in most cities relative to pre-COVID levels, giving another indicator of where things are still not back to normal. However, this also gives us just another clue, as public transport differs greatly between cities. In Europe and Asia Pacific, the CBDs tend to be connected to the suburbs by dense transport networks, and reliance on private car transport is much less common. This is perhaps why the data in Figure 3, which compares traffic levels at end-2021 with pre-pandemic levels, reveals little change in London and Paris relative to other large metros. Singapore and Madrid rely more on road transport for commuting. New York, at ca. 25% below pre-pandemic levels, is notably well-connected by public transit networks.

An uneven global recovery auto traffic change from pre-COVID

Although the United States is experiencing a plodding return to the office, slowly but surely workers are making their way as the virus fades. Yet a distinct pattern is emerging with greater numbers finding their way back to the office in Sun Belt markets compared with greater resistance in the coastal gateways. This may well be related to commuting challenges with the more congested cities experiencing the lowest occupancy rates. According to data from Kastle Systems, which tracks security badge swipes of office users daily, of the 10 U.S. cities tracked, Sun Belt cities such as Austin, Dallas and Houston had higher occupancy rates, ranging from 51% to 60%, than gateway markets such as New York, Washington, D.C., and San Francisco, ranging from 35% to 40%. Unlike previous waves of the virus, there is a sense that this recovery in office attendance will be more sustained. The virus-related hospitalizations have remained low for long enough that major firms are able to announce more concrete plans, and employers are pushing to bring workers back in greater numbers. Indeed, there have been high-profile announcements from dozens of major firms across the finance and technology sectors.

Across Europe, current levels of office attendance seem broadly in line with the return to the office post-Delta and pre-Omicron waves, during the fall of 2021. At that time, Morgan Stanley’s Alphawise survey of office staff showed half of staff to be back in the office full time, with a further 25% working from home between three and five days a week and a further 25% working remotely one to two days. In Asia Pacific, the first wave of the virus was contained well before Europe and the United States, and data shows that Greater China’s office attendance had bounced back to 70% capacity in early 2021. Currently in Asia Pacific, footfall in the office districts of Hong Kong and mainland China remains weak due to the strong containment measures. In contrast, for CBDs in Australia, Singapore, Seoul and Tokyo, office employees are now returning to the workplace alongside relaxation of social distancing measures by the governments. For instance, Australia requires government workers to return to the office, while the Singaporean government increased the guideline for maximum office attendance from 50% to 75%.

Where has there been the most resilience in real estate markets?

The hibernation of activity during the initial phase of the pandemic was extreme, but businesses and staff were supported generously by governments globally, such that job losses were minimized. As lockdowns were eased, economies sprung to life and job creation re-commenced. Figure 4 compares the office jobs after two years of pandemic with the similar position after the Global Financial Crisis (GFC). Two years following the GFC, job levels were significantly lower in much of Europe and the United States, although APAC countries largely boomed on the back of China’s expansion. By contrast, two years after the pandemic, the United States and most countries in Europe are experiencing higher levels of office employment, which is a real boost for office fundamentals. Office job growth rebounded in 2021, and levels currently stand higher than pre-pandemic levels in Spain, France and the UK. In the United States, a few city markets remain within a percentage point below their previous job peaks and several, especially in the Sun Belt region, among them Austin, Atlanta, Dallas, and Miami, are already more than 5% above previous peaks. APAC markets have been a real global standout in terms of office job creation. However, there is evidence of bifurcation with Australia, South Korea and Japan recording robust growth and Hong Kong’s performance quite modest. Australia was underpinned by growth in public sector and finance jobs, while Japan was driven by strong growth in tech-related jobs and professional services.

Office sector employment two years after previous peak

In terms of real estate market metrics, we have witnessed much variation globally, with arguably greater stress on rental levels in APAC than in the United States and Europe. Vacancy rates edged higher in most markets but are now stabilizing in most centers, and even receding in a few. Weaker performance in APAC centers was partly due to unfavourable supply fundamentals, particularly in Hong Kong, Tokyo and Shanghai. More tightly supplied markets, such as Singapore and Seoul, actually recorded modest growth. In the United States, San Francisco was the only U.S. market to experience a double-digit fall in prime headline rents, with New York experiencing a more modest reduction. However, U.S. landlords have offered generous concession packages to contain headline rental falls. In Europe, prime rental levels demonstrated resilience except for a few notable exceptions. Rents even increased in several centers in 2021, Paris CBD, German A centres and London among them.

Implications of a new hybrid work model

The widespread belief is that the new office “normal” will involve much greater fluidity between the home and the office. This inevitably raises concerns for investors, but there are mitigating factors to suggest the market risks are overstated. Figure 5 summarizes risks and potential mitigating factors.

Hybrid working model: risks & mitigants

Increased work/life balance, time savings, and reduced commuting costs are all positive staff benefits of remote working. Companies are therefore likely to keep hybrid working models in place to attract and retain talent. However, clear cultural differences in the approach to the hybrid working model are evident. The strong cultural bias toward collective working tends to favour working in the office. In the United States, while most decision makers would prefer workers to return to the office a majority of the week, they are aware that calling workers back too fast could lead to higher attrition than competitors. Multinational companies are more open to hybrid arrangements compared to domestic firms. In terms of likely outcomes, as firms experiment with the success or otherwise of hybrid working, their longer-term space requirements will remain unclear. Occupier markets might therefore be expected to operate at lower levels of leasing activity and weaker net absorption, which in turn implies vacancy will be “sticky” and slow to erode.

Despite lower attendance, firms will be limited in their ability to reduce office footprints short term. In the United States, it remains to be seen how well staff adapt to the new working model, given that many are returning to the office for the first time in over two years. If it is executed well, employers may decide to consolidate their physical office footprints. Executed poorly, employers could choose one of two extremes, either shift back to full remote or bring workers back full time. Hybrid is expected to win out after the initial growing pains.

In terms of mitigating factors that could limit the stress on office leasing markets, the pandemic is expected to usher in significant changes in attitudes, with potentially positive impacts for floorspace. Global office centers operate on a wide spectrum of densification (floorspace per worker), with many APAC as well as London offices having much denser utilisation than their U.S. and continental peers. Yet the trend for increasing densification has been relentless in many centers over the past decade, and hybrid working could allow for a “natural” de-densification in affected markets, mitigating any excessive return of space. Other mitigating factors include how employers chose to accommodate staff in a hybrid model. The appetite for desk sharing is unlikely to be compelling in an immediate post-virus return-to-work setting. Staff choosing to work from home the odd one or two days will no doubt expect a dedicated workstation when in the office, notwithstanding the fact innovation is often better achieved by the close proximity of team players. Hot desking will also have to be available to meet peak demand, limiting the space saving potential of tenants. And what of future business expansion? Space will need to be made available for such eventuality.

Implications for investment

Given the need for corporates to encourage staff back to the workplace, the quality of office product and associated service offer will need to be higher than pre-pandemic standards. In Europe, we expect demand to remain robust for offices in well-connected central business district locations, particularly in buildings with high levels of well-being and environmental certification. Institutional landlords will need to transform their passive leasing approach into active engagement strategies, working alongside tenants to help them re-define their post-pandemic workplace design, incorporating flexible overspill space optionality where possible.

Hybrid working has not had a significant impact yet on office demand in most Asia Pacific markets, as such investment strategies in the region should be linked to the city fundamentals. Investors will benefit from a value-add strategy in Singapore and Seoul given the tight supply in these markets, upgrading and refurbishing well-located office buildings. However, they may deploy core or core-plus strategies in Sydney and Melbourne in order to capture the potential rental reversion.

The U.S. office market is likely to experience a net reduction in space overall, coinciding with a “reshuffling” of demand. Newer and more centrally located properties are poised to gain market share, whereas older properties and tertiary locations face obsolescence. A consolidating tenant can potentially afford to upgrade their remaining space by paying more on a per-square-foot basis while keeping overall occupancy costs down, creating winners and losers at the asset level. An increasing priority on meeting ESG standards will also steer firms toward top assets. In addition to a talent retention and attraction tool, firms are motivated to use their office space as a means of achieving climate change goals.

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