Just two years ago, office was still cited as the most preferred property type by 84.3 percent of respondents in the ANREV / INREV / PREA Investment Intentions Survey 2020.
But today, it’s hard to miss the headlines about excess office space, as a quick scan of this week’s real estate news will attest. “London has enough empty office space for 45 skyscrapers,” read one article. “KPMG Cuts Office Space by 40 percent in Hudson Yards Move,” said another.
Meanwhile, an article from The Wall Street Journal declared: “America’s Office Glut Started Decades Before the Pandemic.” The story highlighted several factors that contributed to the oversupply – including federal tax breaks, low interest rates and co-working companies that inflated demand – but this surplus remained largely hidden until the pandemic.
This raises the question: which of today’s hot sectors are most likely to face oversupply issues in the future? Below, we highlight two where we see some warning signs.
Biotechnology and pharma were catapulted into the spotlight when healthcare and vaccines became top priorities during the pandemic. Unlike traditional office markets, most life science cluster markets are undersupplied, thanks to high barriers to entry that include the significant construction costs and technical expertise required to build such space.
The challenge to demand, however, is that the firms conducting much of the healthcare- and vaccine-related R&D are start-ups funded by venture capital firms. This is not dissimilar to co-working firms whose own VC funding helped to fuel sizable demand in the office sector.
Notably, although life science VC funding dropped by 18.5 percent year-over-year to $20.8 billion in the first half of 2022, it reached record highs in 2020 and 2021, according to a report from commercial real estate services firm Newmark.
Moreover, it is difficult to accurately gauge demand when the sector’s reliance on VC funding and the unprofitability of most start-ups makes such demand unpredictable. As Anuj Mittal, head of Europe real estate at Angelo Gordon, noted at the PERE Europe Summit in June: “VC is funding what used to be R&D for pharma. There’s a 95 percent failure rate.”
The current industry darling is another pandemic-era winner; e-commerce shopping was a necessity during pandemic-induced lockdowns and has now become a way of life for many consumers around the world. But the sector has shown weakening demand in certain geographies such as China, where the nationwide vacancy rate has risen from 10 percent in 2018 to more than 15 percent in Q1 2022, while net absorption fell 70 percent quarter over quarter and 41 percent year over year, according to a CBRE report.
While the vacancy rates in tier one cities such as Beijing and Shanghai are still relatively low, other parts of the country are seeing new supply outpacing net absorption rate, the report showed. For example, vacancy remained above the national average in most inner China and North China markets, especially tier two cities.
Other issues negatively impacting demand include a surge in covid-19 infections in multiple cities that led to a suspension of manufacturing and logistics operations, as well as reduced consumer consumption. While these factors are believed to be short-term, they also lend an element of ongoing unpredictability to the country’s logistics demand.
As capital piles into today’s en vogue sectors, the glut in US office space has some valuable lessons for the industry. Firstly, actual demand for space may not be what it seems, as there are multiple factors that can inflate or otherwise obscure true demand. And secondly, every sector can be affected by potential disrupters that can dramatically change demand in the future, even if it is difficult or impossible to fathom what those disrupters may be today.