The global move toward hybrid working since the onset of the pandemic has put pressure on the office sector overall, but that pressure has not fallen evenly. Some central business districts have been thriving and others have proven resilient to these changes.
There are many different factors at work, not all of which are transferable from city to city, but there are lessons to be learned for asset owners about where to invest and what can be done to boost moribund investments.
Offices in US cities appear to have been hit hardest, with vacancy rates rising to record levels in larger cities including Chicago, San Francisco and Los Angeles, according to data from global commercial real estate brokerage firm CBRE. Meanwhile, cities such as Berlin, Amsterdam, Singapore and Tokyo have fared much better. US cities have also tended to score lower in terms of office utilization than cities in Europe and the Asia-Pacific region, with many American cities seeing physical occupancy remain stubbornly low.
Except for cities beset with oversupply, such as Hong Kong and larger Chinese cities, Asian CBDs performed strongly in the aftermath of the pandemic, with Seoul being a notable outperformer. Office rents rose 7.1 percent in the year to June 30 and the city-wide vacancy rate fell 90 basis points to a record low of 1.8 percent.
Cultural differences
There are cultural factors that make Asia different. Developed Asian cities are densely populated, which means people have smaller living spaces. Furthermore, the working culture in greater China, Korea and Japan places a high value on collaboration and ‘face time.’
A survey by The Economist found South Korean office workers were the least demanding worldwide with regard to a desire to work from home. In contrast, the office vacancy rate in Australian cities averages 12.8 percent, according to the Property Council of Australia, the highest level there in nearly three decades. However, there is more to the variation than Asian and Western work culture. London’s office vacancy rate is twice the long-term average, while Berlin’s is below its average. There are also variances between major business districts: London’s West End is seeing rising rents but they are falling in the City. Vacancy is falling in the Paris CBD but rising in La Defense. Some cities and business districts have been more resilient than others.
“Of the 41 European office markets we track, 21 have vacancies below their long-term average,” says Donald Hall, global head of research at Nuveen Real Estate. “All seven of the major German markets have office [vacancies] below their long-term average.”
Transport infrastructure is key to keeping workers in the office, argues Hall. “Cities with more resilient office markets tend to be those with good infrastructure, where it’s easier for people to get into the city, which is often due to better public transit.”
Megan Walters, global head of research at Pimco Prime Real Estate, says: “Across Europe and APAC, high-density cities with amenities and good public transport seem to be thriving despite the work-from-home trend, while those in the US are more severely impacted. In high density cities, apartments tend to be smaller and there is more public transport, so people commute to the office. Singapore would be a great example of this: it has efficient public transport and smaller living areas so office occupancy is at pre-pandemic levels.”
CBRE’s Hardest Hit Office Buildings report focused on the reasons for US office buildings suffering more than average in the shakeup of hybrid and remote working practices. As well as a number of asset-level factors, the report also noted a number of factors at the city or district level. One of the most significant of these was crime risk. The research found that the hardest-hit buildings scored 11 percent more on average for crime risk, the largest external driver of underperformance.
This correlates with the resilience of Asian cities to changing working practices, as Singapore and Tokyo are frequently rated among the safest big cities in the world. Smaller US and European cities with lower crime rates, like Amsterdam, have also been more resilient.
Amenities attract users
The report also rated office buildings in terms of amenities – using the number of nearby restaurants as a proxy – and found there was also a correlation between lower amenity scores and the hardest hit buildings.
“CBDs that are pure office blocks will not do as well as CDBs which are more mixed with residential, restaurants, cultural activities and public transport infrastructure,” notes Walters.
“Post pandemic, if people stop going to a pure office area, there is likely to be a downward spiral where people do not feel encouraged to go as there is no one else there. In such cases, we see cities becoming dead in the center, whilst the suburbs will rather thrive.”
Forward-thinking city authorities act to bring a better mix of uses into their CBDs. In 2019, Singapore’s Urban Redevelopment Authority introduced an incentive scheme to encourage more mixed-use development, particularly the refurbishment or redevelopment of older office buildings to create a mix of uses. As well as providing more amenities, the initiative sought to create more residential and hospitality properties on the fringes of the CBD to create an environment with more people outside of working hours. So far, eight new mixed-use buildings have been approved under the scheme.
“People need another reason to go to city centers that is not just about going to work,” Walters points out. “They might want to see friends in bars and restaurants, attend concerts or other shows. City centers need mixed activities to thrive rather than pure offices in one location with little else to do.”
Cities worldwide could do more to bring in people, including converting older office space with lower ESG-compliance into apartments. Global commercial real estate brokerage firm JLL estimates that New York could add more than 32,000 apartments and London more than 8,000 to their respective business districts in this way.
Boosting office buildings’ ESG characteristics can improve their performance and help revitalize cities and business districts. Many cities around the world have older office stock, which lacks the energy efficiency and healthy building characteristics demanded by occupiers today.
JLL found that less than 10 percent of office stock in cities such as Hong Kong, New York and Paris was built after 2015. This is problematic for office owners, as a lack of modern stock will push occupiers into new markets with newer buildings.
“Thoughtful and extensive office refurbishments have been rewarded with 10.7 percent rental growth since the onset of the pandemic – higher than the 7.3 percent seen in new supply over the same period, underlining the resilience that can be found in traditional CBD locations,” says Phil Ryan, director, city futures, global insight at JLL.
“These refurbishments often command substantial rental premiums, which further underscores a supply gap in the market prime for opportunistic and proactive investment.”
Thoughtful development
The factors that make a city successful in attracting office tenants can also be seen in the retail sector. Retail markets worldwide have been impacted by online shopping, but a number of markets have begun to recover, and others have proven resilient.
Asian retail properties have benefitted from good public transport networks and mixed-use developments that deliver a steady customer base that lives or works in the area. The same can be said of many European cities that have shown robust performance this year. Savills data shows retail investment accounted for 20 percent of European activity in the first quarter of this year, the highest level since 2015.
However, retail has faltered in many US cities where it is less accessible and in UK cities where transport is inadequate and planners have failed to encourage mixed-use development. Singapore’s URA also noted that the CBD needed to offer more open space and to be more walkable in order to offer a truly live/work/play environment.
Public open space is not necessarily the province of the public sector, explains Walters: “Public space is important, and so is the management of such spaces and making sure people feel secure and relaxed in that space. One trend that is likely to gain prominence is ‘private public space’ where space is open to the public but is managed by private companies that may have more resources than local governments to do things like curating cultural activities.”
In Asian cities, shopping malls and the public spaces of large, mixed-use developments provide privately-owned public space. For example, in Hong Kong, Henderson Land’s $9.3 billion Central Harbourfront Site 3 development will feature 300,000 square feet of public open space, approximately one-fifth of the floorspace.
In New York, the redevelopment of Hudson Yards features 14 acres of public open space alongside a planned total of 18 million square feet of residential and commercial space.
Meanwhile, in the UK, landed estates such as Grosvenor in London control city squares that act as amenity spaces for residents and workers there.
Something the public-private partnership at Hudson Yards, Site 3 and Grosvenor Square have in common is large areas under common ownership, which is relatively unusual in real estate.
Indeed, most private equity real estate investors seek to diversify their holdings, rather than owning a number of buildings in the same area, says Jani Nokkanen, chief investment officer of Nordic real estate investment manager NREP, and they typically do not co-operate with other asset owners unless they are in joint venture. However, that doesn’t mean there is nothing to be done.
“The first thing to note here is that as a property owner, even if you have only one asset, you should be thinking, ‘How is my asset impacting this area?’ We call it the zip code impact,” Nokkanen says.
“You should always be thinking, what is this asset doing for the area? This is good business; if you are providing something for the community, if you are solving a problem for the community, then typically it is a good investment.”
Many of NREP’s development projects involve larger city areas where the company and its partners can develop a range of asset types, often in co-operation with city governments. “Public-private partnerships and more general co-operation between asset owners and government is always positive for cities and districts,” he says.
Nokkanen also notes that social equality is important if cities and districts are not to fall into a vicious cycle of decline. Just as areas without amenity will be subject to a downward spiral as businesses leave, so will areas which do not promote a mix of social groups. “Again, this needs public-private partnership,” he says.
Even busy CBDs have a mix of social groups, and savvy asset owners work to benefit all of them. In the City of London, UK real estate investment trust British Land’s £25 million ($30 million; €29 million) social impact fund has carried out a number of social initiatives around its Broadgate Estate. These include providing affordable space for local businesses and a pop-up creative space that hosted thousands of artists and 250 shows. The initiative boosted takings at local bars and restaurants and supported more than 1,000 local jobs.
The challenge of underperforming cities and business districts is huge, but as with so many problems, prevention is much easier than a cure. Nokkanen says: “As a property owner or the city government, it’s far more difficult to bring an area out of a vicious cycle of decline than it is to prevent damage in the first place. That means you need to be involved in the upkeep of your zip code and trying to collaborate with the city government and community right now. Then perhaps your assets will be more resilient in the long run.”
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