A Bloodbath for CBD Commercial Office Space? – One future for commercial office space in Australia
A lot has been written about the future of working in the office because of the COVID-19 Pandemic. One possible future is a slow-moving ongoing crisis for the owners of commercial office space in the CBD centres of our major cities driven by the forced experiments of working from home.
That possibility is most stark in my home city of Melbourne. Cushman and Wakefield Market Beat Report details that in Melbourne an extra 24.3% of premium space, 12.8% of A-grade space and 15.9% of prime space (combined premium and A-grade space) is under construction at the same time that demand has dramatically fallen. Cushman and Wakefield report that net-effective rents for premium space are now 7.8% lower than the last quarter of 2019. In addition, JLL reported in early July that:
In Australia, 12 per cent of office leases are due to expire in 2020, according to JLL data. But as a result of ongoing economic uncertainty, a majority have been extended into 2021
While it is clear that government policy is playing a role in the lease extensions, it also means that companies are hedging their bets to see what they might do in the future.
A very simple scenario says that we could have a huge reduction in the amount of office space required if the following happens:
- 20% of people that worked in the office five days a week change to work permanently from home.
- 10% of people that worked in the office five days a week, end up being replaced over time by people from other places, again working from home. The experiment of work from home results in a widening of the talent pool that is available to companies because if you have someone working from home 20km away, there is no real difference to someone working from home 2000 km away.
- 50% of people that used to work in the office five days a week now work from home 60% of the time but do so by working extended hours in the days that they come into the office and so are only in the office 30% of the days they used to be.
If we multiply these numbers out, then we get a 65% reduction in the number of office days required even though 70% of people are still working in the office on a regular basis.
Obviously, this is just maths so let us look at what the evidence might be:
- A huge percentage of people that work in offices in Australia have already had the taste to what working from home might look like. The current lockdown in Victoria is extending that experiment. Possible for at least another three months. Currently, NSW is hovering on the edge of restrictions being imposed again if the current clusters move to the status of uncontrolled outbreaks, which is certainly possible. The ABS Household Impacts of COVID-19 Survey, 29 Apr – 4 May 2020 said that:
Nearly half (46%) of all Australians who were working in late-April to early-May said they were working from home
And 89% of those that said they were not working from home said it was because they could not do their job from home
- In his article The Future is Minimum Office, Not Zero Office Stowe Boyd quotes the Gallup State of the American Workplace 2017:
“all employees who spend at least some (but not all) of their time working remotely have higher engagement than those who don’t ever work remotely.
And those that work remotely 60%-80% of the time say they are more likely to strongly agree that working remotely makes them more productive.”
If this applies across the board, then there is a significant motivation for people to work from home part of the time, beyond the cost savings for a business.
If this scenario does unfold, then I expect that it will do so quite slowly due to:
- Extra space required for office space in the short term to maintain social distancing.
- The long-term nature of commercial office space leases.
- The slower change of replacing people who leave, with people from other places.
- The inertia to change of some organisations who believe that you can only maximise productivity, and social networks through being in the office together.
Even a slow-moving drop in demand, meeting up with an increase in supply as current construction projects come to fruition, can have quite catastrophic effects on rents.
Significantly lower rents mean an adjustment in returns which can have the effect of:
- Squeezing margins on services and inputs to office space.
- Breaching loan covenants via asset revaluations.
- Causing distressed assets to come on to the market, reinforcing the revaluation cycle.
Of course, as well as losers in these scenarios there will be winners including:
- Strong balance sheet companies and super funds that can buy distressed assets.
- Some service providers such as food courts and cafes in the strongest office space competitors who can benefit from increased office hours by lengthening their opening hours for the people that work extended hours while saving on rents.
- Mortgage brokers and building companies who can service increased demand for standalone office spaces in homes through renovations and extensions to existing properties.
- Property owners and real estate businesses further out from the CBD that are likely to see increased demand and prices for house properties with good transport links, good internet connections, and the space for home office space.
The purpose of scenarios is not to predict the future, but to think about alternative stories to the ones that you may have in your head. Quite a few people I have spoken to this scenario about in the last few days have indicated that it is too far out on the edge of possibilities.
My view is that I am not sure that is the case. The strategic thing to do is to plan for the possibility occurring by thinking about whether your current strategy survives if this scenario comes true. If the answer is no, then you should be preparing an alternative strategy, and deciding what signposts to monitor. So that if this scenario begins to emerge in the real world you are ready to change your direction at the appropriate time. Strategy is all about orientating yourself to the landscape that you are operating in. When we are experiencing periods of high uncertainty, then constantly thinking about what that landscape might be in an open and questioning way is a critical skill.
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July 13th 2020