According to the latest report by M&G Real Estate Property Research, the property market may experience structural changes due to a wider and regular implementation of increased work from home among employees after the pandemic; two or more days of WFH would drive up commercial real estate vacancy in gateway markets.
Commercial real estate vacancy rates are likely to rise, particularly in the scenario when companies plan for employees to work from home for two or more days in a week, in the range of around five to twenty percent.
Well-located and high quality assets are expected to be more resilient in this event as occupiers are expected to place continued emphasis on the benefits of economies of agglomeration for innovation, talent attraction and retention; as well as the wellness of employees and ESG.
The COVID-19 pandemic has resulted in more white-collared employees working remotely from home for an extended time, enabling companies to better assess the proportion of employees that could work remotely for a sustained period of time. Allowing employees to work remotely would help companies with their business contingency planning and also provide flexible working arrangements to promote employee wellbeing.
This has called to question the future of the office market with the increased likelihood of more companies adopting more flexible work arrangements for their employees going forward. The ‘new normal’ could see more employees given the option to work from home/remotely as much as three days a week. As a result, this is likely to push companies to reassess their business space needs and also opens up more options to optimise space usage.
In the event that regular WFH becomes widely mainstream among the finance & insurance, real estate, business services and ICT industries (FIREBI), vacancy rates in the APAC office markets are likely to be negatively impacted. These four sectors have been identified as significant sources of demand for the office market and are likely to adapt quickly to flexible/remote working due to available resources and higher preparedness for an increasingly digitalised economy.
The following analysis conducted by M&G suggests that:
Markets with higher exposure to the FIREBI industries will likely be more significantly impacted
The office building is here to stay, with a focus on quality over quantity
Allowing employees to work from home 20% of the week (or 1 day WFH) is estimated to increase vacancy rates in the range of around 2-4% across cities, where current vacancies for most markets are below 10-year average rates
Increased WFH in the range of 2 to 3 days (resulting in 40-60% manpower in the office) would raise vacancy levels to levels higher than the maximum point over 2009-2019 across markets.
Singapore, Seoul, and Hong Kong would be most negatively affected, in part due to the higher existing vacancy rates in these markets (on a market-wide level) and the relatively higher exposure to the FIREBI industries
The analysis focuses purely on the impact of increased WFH among the FIREBI industries per city, and has not factored in the potential demand of office space and the incoming supply in over the medium term. It also does not account for differences in sub-markets or building quality.
While the calculations assume that the FIREBI sectors implement similar WFH arrangements at a same point in time, the likelihood of that occurring is expected to be low. Occupiers are expected to implement increased WFH at different rates depending on their corporate and real estate strategies as well as their existing lease arrangements.
It is also important to note that offices are not expected to become obsolete given that they remain an integral platform for employees to collaborate, exchange knowledge and develop trust within a secure space.
Key industries contribute to more than 50% of total office space take-up for most APAC markets
The FIREBI sectors have been identified as potentially adopting more flexible work arrangement for employees on a wider and more regular basis as they are likely to be equipped and positioned for remote working, especially due to increased digitalisation of their businesses even before the outbreak of the COVID-19 pandemic. The finance & insurance and ICT sectors in particular have also typically been in the forefront of shifting office trends, such as the implementation of activity-based work environments in more recent times.
The FIREBI sectors are also estimated to contribute to a significant part of total office take-up in the APAC markets (Figure 1). Unsurprisingly, cities such as Seoul, Singapore, Tokyo, and Hong Kong have a higher proportion as their economies are largely dependent on these sectors. Thus, any changes in the way employees in these industries work is expected to create a ripple effect in the APAC office markets.
The office building is here to stay, with a focus on quality over quantity
The typical modern office environment now reflects something more engaging than rows of identical cubicles. Its purpose had already started to evolve prior to COVID-19. Office space can help companies to innovate and create. It allows for collaboration – at a level beyond the continuously interrupted and awkwardly apologetic virtual meeting. Increasing flexibility levels may ultimately create an even bigger headache for managers. How do you coordinate collaboration if the team is split across multiple locations? The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested.
The office also forms a part of an organisation’s values, helping to define its culture. In the battle for talent, this is crucial. First time entrants to the workplace now largely identify with Generation Z, often with already entrenched ideas around social interaction, wellbeing and work ethic. It is arguably this demographic that firms need to cater for most.
To accommodate this new format, the direction of travel has been quality over quantity. Office optimisation has been underway for more than a decade. Obsolete desk space has been replaced with break-out coffee spots, innovation hubs and wellbeing facilities. So while space per worker has been falling, fit-out costs and service charges have been trending upwards. For occupiers, this has helped to level out their overall costs. For landlords, the rental premium attached to the ‘right’ space is of even greater value. COVID-19 will surely accelerate this trend.
With increased WFH, occupiers likely to plan for smaller percentage at work
Companies are likely to plan for fewer employees in the office with the introduction of WFH in which the planned percentage of employees is in the office is inversely proportional to the number of WFH days. For instance, a plan for 40% of employees to be in the office would translate to a three-day WFH for employees in a week, 60% would translate to a two-day WFH, and 80% would translate to a one-day WFH. It is also assumed for this analysis that currently, most occupiers plan their office space area based on 90% staff strength on average. The comparison between how office space take-up may change with different percentages of employees at work is thus compared to a 90% base.
The total office area occupied by occupiers is taken as the sum of the i) area for work desks required and ii) the area for common space with circulation factored in. This analysis assumes that occupiers split office space per employee between office desk and common area in the ratio of 50:50 on average across markets. For instance, in Singapore where the average office space density is 100 sf per employee, 50 sf would be allocated for office desks and 50 sf would be allocated for common space (including meeting rooms and collaborative space).
With fewer employees in the office on a regular basis, the space required for work desks is expected to be planned in proportion to the percentage of employees expected to be in the office (e.g. a company would only require work desk space for 40% for employees for a three-day WFH arrangement, down from the existing status quo of planning for 90% of employees). However the amount of common area space is held constant at the existing status quo for 90% staff strength to ensure higher office space density per employee for social distancing over the near to medium term and buffer space for a potential increase in employees in the office at any point in time.
Based on the above assumptions, the estimated office space the FIREBI sectors would require under different WFH scenarios, with changes to the area required for work desks while holding existing common space area constant (i.e. unchanged from the status quo).
Two or more days of WFH would drive vacancy up significantly in gateway markets
Changes in office space requirements for the different WFH scenarios were used to calculate the potential vacancy rates across APAC markets. Table 2 provides a summary of the changes in occupancy as a percentage of total office stock due to increased WFH as well as the resulting vacancy rates.
Unsurprisingly, increasing WFH allocation results in rising vacancies across all markets. With a one-day WFH arrangement (or 80% in the office), the change in occupancy is limited to a range of around two to four per cent across markets (Table 2). It may also be likely that occupiers may not downsize if their plan is for 80% of employees to work from the office. Thus, a one-day WFH arrangement is not expected to have material impact on the APAC office markets.
Secondary cities such as Osaka and Nagoya appear to be more resilient than gateway cities such as Tokyo and Sydney based on the changes in occupancy as a percentage of total stock at 1.8 and 2.7% respectively (Table 2). This can be mainly attributed to these markets’ relatively low exposure to the FIREBI sectors.
However, a mainstream WFH arrangement of two or more days is estimated to drive vacancy up significantly across most markets, to levels higher than the maximum point between 2009 and 2019 (Table 2) when most markets were recovering from the GFC and a supply influx.
Singapore, Seoul, and Hong Kong are expected to be the most negatively affected (Figure 2), in part due to the higher existing vacancy rates in these markets and their relatively higher exposure to the FIREBI industries in terms of estimated total office take-up as a percentage of total office stock.
Headwinds lie ahead for office markets, investors need to be more selective
Prior to the COVID-19 pandemic outbreak, some occupiers have already introduced WFH options for employees and corporates have sought to reduce their space footprint through activity-based layouts, thus reducing the space required for work desks. The average office space density per worker has reduced over time as a result.
It is expected that increased WFH on a more regular basis would become a more widely adopted practice going forward as companies seek ways to recover profitability post COVID-19 and to improve resilience in their operations. It is already happening in some markets- for instance in Tokyo where companies such as Fujitsu and Lenovo have announced that they would seek decrease to reduce their office footprint over the coming years.
While this paper’s analysis does not distinguish between building quality or sub-markets in each city, or factor in supply additions or demolitions, it seeks to provide a quantified estimation of the potential downside impact on the APAC office markets from a wide and regular adoption of WFH among major office occupiers from the FIREBI sectors. The implications are clear- office markets in the region are likely to experience some demand headwinds over the medium to longer term in such a scenario and there is a need for investors to be increasingly selective in their office ‘stock pick’ for a more defensive portfolio against potential structural changes .
For investors, asset location and quality should be even more crucial elements/considerations. More resilient office assets in terms of occupancy are expected to be located in submarkets where occupiers can benefit from economies of agglomeration. This is expected to remain relevant for corporates as offices will still be integral platform for employees to collaborate, exchange knowledge and innovate. These factors help an organisation spur innovation that is vital for growth – even more so in a period when most industries are facing digital disruption and more knowledge work is required.
Occupiers are also expected to place a premium on higher quality assets that address considerations of wellness, services, and ESG for their employees’ welfare and to meet their company ethos. This is expected to lead to an increased bifurcation in the office market in terms of building specifications and quality over the longer term.
(Ed. Featured image by Photograher Aleksandar Pasaric.)