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Insights
The remote work revolution has changed office space
Investors have many concerns about the market for office space. But we believe the picture is not quite as dire as some might suspect. Office real estate around the globe has responded very differently from one country to another. And even in the hardest-hit office markets, some segments continue to show strong returns. However, investors are right to be careful, and trends are changing offices around the globe.
1. Remote working is becoming more widespread
No global region has returned to normal attendance since the pandemic, but the Asia Pacific (APAC) region leads the way, followed by Europe and the U.S.
Cultural bias toward face-to-face interactions and team building have bolstered attendance in APAC. Additionally, tight living quarters in major office centers across APAC and Europe have drawn workers back to the office. Finally, superior public transit means workers spend less time and cost commuting.
The U.S. lags partly because workers rely on car travel, with long commutes exacerbated by aging infrastructure. Larger living quarters make working at home more feasible, and workers are reluctant to give up the flexibility of remote working.
2. Leases active prior to the pandemic are expiring
The average office lease blended across markets and lease types (i.e., new leases versus renewals) is 7.75 years.1 Given the long-term nature of office leases, many active leases were signed prior to the pandemic. These firms have not had the opportunity to make space decisions with full knowledge of the new hybrid environment.
On the other hand, an estimated 50% of leases that were active prior to the pandemic have expired, closely in line with demand losses to date, suggesting the trend is on pace for the projected decline in space needs.
3. The U.S. confronts excess supply
Even with an expanding knowledge-based workforce, we believe the U.S. will likely need less office space in 10 years than prior to the pandemic. Current owners face formidable near-term risks, including debt maturities, escalating capital expenses and a weak leasing environment. We believe this distress should help force a repricing of assets to current market conditions and allow new owners with lower cost bases to improve assets and compete for future demand.
And a flight to quality trend has emerged. Older properties without significant renovations are losing a heavier share of occupancy. They generally lack sufficient rents to justify meaningful investment and are becoming stranded assets. Newer properties built to modern standards are increasingly taking market share.
4. APAC faces economic challenges
APAC occupancy has recovered across many regional markets, with office attendance rates approaching 80% for Japan, Hong Kong and South Korea versus 50% for the UK and U.S.2
But economic growth in the region is weakening in 2024, and the hit to business sentiment and profitability has dampened medium-term occupier demand for office space. More than ever, we believe investors in search of recurring income returns should focus on well-located, quality buildings with strong environmental, social, governance (ESG) credentials.
5. Europe is driven by an environmental agenda
Energy efficiency and decarbonization have become particularly pertinent for corporate occupiers, accelerating the bifurcation between relevant and obsolete office stock. Post-pandemic office attendance and soaring energy bills due to the war in Ukraine have only served to reinforce this trend.
European cities vary considerably in terms of the age of the stock. Upgrading space at lease expiry is expected to play a major role in reversing obsolescence in coming years, and we believe environmental upgrades will likely play an important role in sector revitalization.
6. U.S. workers are back in the office mostly part-time
In the U.S., whether by choice or mandate, many workers are heading back to the office, but expectations have changed. Attendance peaks mid-week at around 60% occupancy.3 Most fully remote firms are moving toward hybrid schedules. Requiring a physical presence in the office for even part of the week keeps workers living and working in the same metro area, which has far-reaching ramifications across property sectors and markets. Conversely, many previously fully in-office firms are also pivoting toward hybrid models, thus muting the impact overall.
The risks are real, but we see space for winners
We believe the office market will be challenged for years to come. However, certain factors may mitigate the headwinds, including future job growth and a renewed commitment to building out space that fosters collaboration. We believe careful asset selection backed by strong market research and purposeful business plans should generate opportunities. Regardless of the region, we believe investors will be wise to prioritize green credentials and spaces that foster collaboration.
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Endnotes
Sources
1 Source: CompStak, Inc.
2 Source: CBRE Group, Inc.
3 Source: Kastle Back to Work Barometer, https://www.kastle.com/safety-wellness/ getting-america-back-to-work/
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Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Performance data shown represents past performance and does not predict or guarantee future results. Investing involves risk; principal loss is possible.
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All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time.
As an asset class, real assets are less developed, more illiquid, and less transparent compared to traditional asset classes. Investments will be subject to risks generally associated with the ownership of real estate-related assets and foreign investing, including changes in economic conditions, currency values, environmental risks, the cost of and ability to obtain insurance, and risks related to leasing of properties. Real estate investments are subject to various risks, including fluctuations in property values, higher expenses or lower income than expected, and potential environmental problems and liability. Please consider all risks carefully prior to investing in any particular strategy. A portfolio’s concentration in the real estate sector makes it subject to greater risk and volatility than other portfolios that are more diversified and its value may be substantially affected by economic events in the real estate industry. International investing involves risks, including risks related to foreign currency, limited liquidity particularly where the underlying asset comprises real estate, less government regulation in some jurisdictions, and the possibility of substantial volatility due to adverse political, economic or other developments. As an asset class, agricultural investments are less developed, more illiquid, and less transparent compared to traditional asset classes. Agricultural investments will be subject to risks generally associated with the ownership of real estate-related assets, including changes in economic conditions, environmental risks, the cost of and ability to obtain insurance, and risks related to leasing of properties.
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Certain information contained in this document constitutes “forward-looking statements” within the meaning of the federal securities laws and the Private Securities Litigation Reform Act of 1995 regarding the real estate market and the office sector within the real estate market. These forward-looking statements can be identified by the use of forward-looking terminology, such as “believes,” “expects,” “potential,” “continues,” “may,” “will,” “should,” “seeks,” “predicts,” “intends,” “plans,” “estimates,” “anticipates,” “likely,” or the negative versions of these words or other comparable words thereof. These may include our ability to successfully navigate through the current economic uncertainty, statements about plans, objectives and expectations with respect to future operations, and statements regarding future performance and statements about macroeconomic trends and market forces. Such forward-looking statements are inherently uncertain and there are or may be important factors that could cause actual outcomes or results to differ materially from those indicated in such statements. We believe such factors include the financial condition of our company and our portfolio and the state of financial markets. We believe these factors also include but are not limited to those described under the section entitled “Risk Factors” in our Annual Report on Form 10-K for the year ended 31 Dec 2023, and any such updated factors included in our periodic filings with the Securities and Exchange Commission. Except as otherwise required by federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future developments or otherwise.
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