COMMENT: The office sector is facing an “evolve or die” moment as it, like other sectors, faces unseen levels of disruption owing to the coronavirus pandemic.
Many are predicting the death of the office, but while office space might look different as we emerge from Covid-19, the pandemic actually marks a turning point rather than the death knell for the office. It has acted as a catalyst for change.
The struggles of the office sector began long before lockdown. The London office market has been underperforming since 2016, and market rental growth was already dampened prior to Covid-19.
This has resulted in a tenant’s market for the past four years, with landlords offering incentives including rent-free periods, shorter leases and more frequent break clauses to drum up sufficient business, and Covid-19 has undoubtedly accelerated this.
The exodus from offices sparked by lockdowns across the globe this past spring has led to office vacancy and weaker demand. In London, this has put downward pressure on rents.
Overall, office REITs have done better on rent collection than anticipated at the start of the pandemic. However, this is expected to deteriorate in Q3 (and even in Q4) as updates emerge, given reduced trading revenues for many occupiers in Q2.
Some office occupational models may become unviable, and we are likely to see the death of serviced spaces. The focus on safety and social distancing measures means it is likely we will be seeing increased consolidation of the serviced and co-working sector, which is predicated on a high-density headcount.
Meanwhile, in the office investment market we have seen opportunistic buyers close some investment deals at lower prices.
London office values are being consistently buoyed by overseas investors, accounting for just under 75% of acquisition activity since 2010.
But the reliance on overseas capital presents a clear vulnerability for the market in the face of continued travel restrictions making it more difficult for purchasers to tour assets and carry out due diligence.
Overall, office space still has its place, with some core benefits still ringing true. These include better teamwork and innovation; more effective building of teams and skill sets through training; improved employee mental health and well-being and headquarters continuing to serve a pivotal role for several business functions – for example, certain areas of financial trading, given risk management as well as data-sensitive or confidential data processing roles.
While offices will remain an important part of business life, we do anticipate the evolution of the office market in the coming months. Densities will undoubtedly be lower, and more people will opt to work from home for a day or two a week, in order to better manage childcare or work-life balance. This could see occupiers focus more on a strategic prime city office building, rather than a mix of secondary offices.
There is also likely to be a considerable emphasis placed on the quality of office space and occupier amenities, which will leave certain buildings, and certain investors, behind. But those who can invest and meet new occupier demands will continue to see healthy investment returns and happy tenants.
Colm Lauder is a senior real estate analyst at Goodbody