US office markets and the possible threat to the country’s banks remain in the glare of investors globally. With a far higher prevalence of remote working in America than other global markets, US office yields are under pressure across the board.
Other markets look more resilient. But question marks linger about the future of offices generally and we are far from a consensus.
Three years after covid began, it is clear hybrid working is here to stay. We are seeing many CEOs offering full hybrid work while others want staff to come back to the office.
But how vulnerable office markets are, to a large extent, depends on the city.
There are three aspects to consider. Firstly, how big dwellings are. Do people have easy access to a home office? Compare Los Angeles, an expansive city with typically low-rise housing with gardens, to Tokyo, where people often live in small apartments, even with elderly relatives.
Secondly, how difficult commutes are. Commuting into Frankfurt is not the same as commuting into New York. The first is smaller with excellent transport links, meaning the barrier to going into the office is lower. To New York City – a dense metro area – more people spend more time commuting.
Thirdly, there is presentism culture. In Korea, employers expect staff in the office. In Australia, employers are more relaxed. So, office occupancy in Seoul is almost at pre-pandemic levels. Australian cities are not.
Based on those aspects, I think US office markets are most vulnerable. Dwellings are big, commutes are long, and culture is not particularly presentist. Take Houston, where office vacancy rates are now around 25 percent. The city is spread out, dwellings are generally large, and culture is fairly relaxed. There, employees’ return to the office is estimated to be around 60 percent of pre-pandemic levels.
It is also important to consider dynamics within cities, rather than just across cities. The best offices have the right ESG credentials and best transport connectivity, ideally situated in industry clusters. Office towers in the City of London tick these boxes. Newer buildings in London’s West End also look resilient.
In Paris’s La Defense, however, buildings tend to be older. The Grande Arche – the district’s landmark building – was completed in 1989. Likewise, 1 Canada Square in London’s Canary Wharf, completed in the early nineties. Today, these offices are better connected than before. But they have to compete with still better connected, city center office markets.
The best-in-class, well connected office is here to stay – it will not face conversion to an alternative use. For this, rents are even increasing.
That said, not every tenant will pay the rent required for ultra-prime offices. As such, there remains a place for well-connected offices of a lower grade. But it remains to be seen at what rent, and how liquid these assets are.
While we can look at what happened with the retail sector as a guide as to what might happen with offices, caution should be taken in drawing the same conclusion. The retail sector suffered the triple whammy of deflation in fashion prices, an excess supply of assets over many years and, most importantly, the growth of ecommerce.
Such multi-pronged adversity is less present in the office sector. Working from home will have an impact. But the sector does not suffer from the same over-construction, deflation and competition that retail did.
Uncertainty is inevitable as the return to offices continues to unfold and office markets adjust to changing requirements. However, there is still demand for shared workplaces, and well-connected offices that meet modern occupier requirements in resilient submarkets, we believe, remain staple assets.