Office investment: a time of opportunity?
Our 2019 thought leadership paper on the Future of Workplace Investment explored what investors should be doing to keep pace with the "workplace revolution".
Read our thought leadership report on the Future of Workplace Investment here.
Set against a backdrop of strong demand and weak supply, and WeWork cementing its position as the top holder of office space in London, investors were focused on the need to adapt to the co-working challenges, embracing occupiers as "customers" and providing creative, high tech environments that attract the best talent.
Fast forward 18 months and investors in offices are facing even more fundamental changes as a result of the Covid-19 pandemic. 2019 was the year of co-working, hot desking and high density occupation. 2020 is the year of social distancing and home working. What will the future look like – and how can investors position themselves to meet it?
Short term trends
From early on in lockdown working from home was forced upon every single office worker, Zoom became a household name and webcams quickly went out of stock on Amazon. Some businesses were already ahead of the curve with home working policies and considerable investment into the necessary technology. Others had to play catch-up quickly. Nonetheless, investors have told us this has largely been successful. Clearly many office workers will be keen to get back to routine, to escape small city flats, and to see colleagues. Many others will want to retain the new found benefits: no commute, more time with family, more time out of the city. Even if Covid-19 disappeared overnight, it is difficult to imagine occupiers returning to a "5 days a week in the office" model. Many occupiers are revisiting their business models and considering whether they will need as much physical office space in future.
The space that we need is changing again, at least in the short term. One trend identified in last year's paper was the move towards higher density offices, with more open plan, more hot desking and greater use of technology and M&E to increase a building's capacity. This may not now be compatible with a socially distanced work environment, particularly if Covid-19 lingers for a while yet. So while occupiers might need space for fewer people, the amount of space they need per person will increase at least in the short term.
The traditional lease model is not nimble. We are unlikely to see an overnight structural change in the office market. The majority of office leases still follow the traditional institutional model, so for some occupiers the opportunities to downsize will not arise until years into the future – unless they can negotiate an early release from their investor landlords.
The idea of flexibility for the occupier is young – but not new. Investors have already been preparing for a potential rise in demand for more flexible lease terms. Some occupiers have been inspired by the co-working model and now expect room to grow (or shrink) built in on day one, shorter lease terms and more frequent break rights. Some of the larger co-working operators have already attracted major multinational occupiers away from traditional investor landlords by offering these things. The traditional investors have themselves become more fluid in response – incorporating co-working and "overflow" space into their schemes or partnering with co-working operators.
The immediate impact on serviced office providers has been significant and adverse. Users tend to be more flexible and are on shorter terms, with more flexible contracts, than traditional institutional leases so could more easily walk away when lock down was imposed. A large number of co-working users are smaller companies or freelance workers who can just as easily work at home. This has been compounded by the significant increase in the amount of serviced office space available over the last 5 years. But is this significant adverse impact just short term? As businesses reassess their needs, many that once would have preferred a 5 year institutional lease would now be seriously considering serviced offices. Serviced offices would allow the flexibility to move again in the short term once the outcome of the pandemic is clearer. It would also give more flexibility in location, allowing offices in multiple areas to avoid the need for staff to commute as much. The benefits of co-working are still there to be taken. One of WeWork's appeals is to allow freelancers, small businesses and start ups to work in the same space, share ideas and mutually benefit from proximity to one another. Serviced office providers and users need to work out how that can still be achieved safely.
Downsizing by occupiers is a concern for investors: but prior to the pandemic the supply of new office space was low, particularly in London, and vacancy rates were also low. This could mean that any impact will not have as stark an effect on the office investment market than would have been the case at a different point in the cycle.
Demand from overseas investors is still strong. The much talked of "wall of money" waiting to crash down on the UK as soon as Brexit uncertainty was put to bed barely had time to land between the Tory election victory and the pandemic hitting.
Despite a recent willingness to diversify to other asset classes, overseas investors remain attracted to offices as an asset class. We see this intensifying as yields become more competitive. Also, for domestic and overseas investors alike, we need to factor in finance, with lending rates now at record lows. Clearly there will be strong demand for such cheap money, thought it remains to be seen whether banks are willing to lend at sufficient volumes to buoy the investment market. Sterling also remains relatively weak compared with major currencies, which goes some way to mitigate other uncertainties for overseas investors.
Longer term trends and opportunities
There is no doubt the office market will live on. Investor landlords will have to adapt to their customer's needs. We explored these needs in last year's paper, and many of these needs will not have changed as a result of Covid-19. Some have, in particularly density, but there are new, more complex, and more immediate needs. Landlords will need to engage quickly. Physical changes to buildings will necessarily take time, and will cost money, but the structure of leases can be changed more quickly – tenants may look to re-gear, with more break options. Investors and valuers may have to accept this as a new normal.
Whilst we all deal with the immense challenges Covid-19 has thrown at us, we need also to be asking what do want 2 years' time to look like? There are clearly opportunities amongst these challenges, in particular the move towards zero carbon, and the increasing role of ESG. Investor landlords should be considering what needs to be done to take advantage of the opportunities. Many will have already been preparing for it before the pandemic, for example embracing greater flexibility triggered by the rise of co-working, or by incorporating ESG into their investment criteria.
The trends towards "best in class" placemaking are likely to continue. The virus has thrown into even higher profile the impact that our previous working patterns have had on the environment, the importance of access to outside space and of maintaining a healthy balance between work, family, body and mind. There are further opportunities here for the creators of high quality places.
What about a move a way from cities? Is the ever increasing density of city centres, particularly in London, going to plateau or even decline, as the office workforce moves out to regional and out of town offices? If so, will this make city centre investor more affordable, and create opportunities for out of town investments?