The question I have been asked most frequently by clients over the last 6 months is ‘what is the future for the office sector’. COVID-19 has resulted in a number of different factors impacting the largest CRE sector; some of them are cyclical and some are structural. On the structural side we have the opposing forces of greater working from home versus a move towards de-densification. Cyclically, we are emerging from one of the world’s greatest ever economic shocks, the resultant loss of office-using jobs, higher vacancy rates and consequently a downward pressure on rents.
In our Global Office Impact Study & Recovery Timing report, we examine the effect that these forces have on office markets across the globe. The key findings show that, unsurprisingly, there will be a significant hit to office demand as a result of the global recession and at the same time the office sector will be re-shaped by the increase in remote working. This latter structural change causes an initial drag on aggregate demand across Europe of 17.4%.
However, most European cities have very low vacancy rates, both by global and historical standards, and this will limit the downside of individual markets at this difficult time.
By Q3 2022, we expect office demand to turn positive again, driven by increased office-based employment. This would be a 10-quarter recovery period which is similar to that of the GFC.
In addition (and this is perhaps the key to the report) the growth beyond 2022 of net office demand will be significant until the end of the decade (some 35 million sq m). This is despite the drag on demand due to ‘working from home’. And the reason for this is that many of the jobs that the global recovery will create are knowledge based - for example in technology and life sciences - where there are requirements for collaboration and community.
It is for this reason that I remain confident that the office will survive and thrive, and consequently will continue to be a significant CRE investment sector.
One of the sectors that has been a ‘winner’ out of the COVID crisis has been logistics (when did we stop calling it industrial?!). This is obviously no surprise given the huge acceleration in e-commerce that came about as billions of people across the world were in some form of lockdown.
So, it has been no great surprise to see that there have been a number of core deals, and some non-core ones, in this previously unfashionable sector. In some of the Core+ deals we are starting to see yield compression – the buildings need to be in core locations but the “+” element is another factor, such as a shorter lease or older building. This is proving attractive to those investors who are being priced out of the truly core market. We certainly did not anticipate that we would see such strong appetite for these types of deals so quickly, but in a recent survey we undertook on Investor appetite, 52% of respondents said they were looking to increase their allocation to the Logistics sector in the foreseeable future. 62% of our respondents also felt that we would see continued yield compression on specific assets over the next 6 months, with 17% feeling this shift would be across the whole sector.
Rental growth is starting to come back onto the table, albeit this depends on the micro-market. The specialist operators are most bullish in this respect and are best placed to take advantage of it. This will be a defining trend of the coming cycle, as the specialist platforms look to outperform the market.
Additionally, retention rates remain above the long-term average, as occupiers look at strategies including ‘blend and extend’ on their core operational portfolios. The capex required to move can be a hindrance, so partnership with landlords on extension initiatives can benefit all parties.
I’m pleased to see, though, that major narratives such as ESG remain paramount, and whist COVID has dominated the immediate thinking, the sustainability agenda remains at the forefront of considerations on buildings and location. This is a long-term trend and remains a priority consideration.
Two weeks ago, below, I wrote about how attitudes to the office seemed to be changing - after an initial weight of opinion towards ‘why do we actually need an office?’ there has been a swing back to a realisation that the office provides a much needed focus for collaboration, learning, mentoring and cultural engagement. Well, after two weeks of quarantine, having got caught out in Spain by the Government’s announcement, I can tell you that I have been itching to get back into the office!
So, it was a relief to be able to head back this week to our London offices, even if the social distancing measures still make it all a bit surreal. (A big shout out, by the way, to our facilities and on-site management teams who have made the return to the office a really positive experience).
What of the real estate markets? It is worth noting that, whilst the macro mood has dipped as we’ve seen a resurgence of COVID-19 in some areas and a renewal of lockdowns, the mood of investors has not really suffered. Our latest real estate sentiment survey shows that the outlook has continued to edge upwards due to a better perception for transactions and deal pipeline.
In addition, there is an improved sentiment in the debt markets with more real estate lenders open to financing new deals compared to two months ago and with pricing gradually returning to pre-COVID levels.
On a sector basis, the polarisation in retail continues to grow - with food stores in strong demand, some retail warehousing and outlets seeing good interest, but in-town centres and high streets feeling the pain. Elsewhere, logistics continue their ‘favourite’ status.
It is still too early to be sure how the end of the year will work out - demand is there from investors, but will we see enough supply in the market? Off-market transactions will therefore remain a focus. However, with many investors working to year-end targets, there is a mood in many markets to get things done if possible. We therefore still have hopes in Europe for a busy end to the year!
The last few weeks have seen a steady increase in the number of people spending time in our corporate offices in London. In many ways it feels like a regular summer, with many people, including myself, being away from their desks on vacation. My arrival in the Balearics coincided with the announcement by the Government that I’ll be entering quarantine upon my return (not just me of course), just when my working pattern of remote and office was starting to become more established!
The summer has also seen a number of businesses communicating a different position than they did early during lockdown. People that were questioning the purpose of an office have become advocates for the value of bringing people together in a corporate environment. There is a sense of inevitability that the true purpose of an office workplace will be re-established. Those decrying the need for corporate headquarters have been overtaken by the physical and emotional needs of the people that fill the very desks that have been bereft of their occupants during the preceding months.
People have a need to be around others and it’s becoming clearer that ideas, collaboration, inspiration and enjoyment at work come from being with and around colleagues and friends.
As might be expected, we’ve also seen an increase in investor activity and interest during the past month. There is a recognition that ‘prime office’ isn’t going anywhere as a valued asset class and a key component of a successful portfolio. The challenge for many buyers right now is the availability of assets. The market is ‘over-subscribed’ with more bidders than there are available assets. We haven’t seen the price chipping that some erroneously expected, in fact in general we are seeing prices at the quoting levels with a number of under bidders on each property.
We absolutely recognise that the working environment will, and should, become more fluid, more flexible. Why would we remain with a notional 9-to-5 Monday-to-Friday working week, when there is far more to be gained from recognising that we open ourselves up to a broader talent pool by offering a more flexible working structure?
The weight of opinion is shifting more heavily back towards the office being the cornerstone of our new way of working. The future will certainly be different and that is one of the positives we can take away from the terrible crisis in which we’ve found ourselves. I, for one, will be very glad to walk through the doors of my office building again after my holiday (and, yes, enforced isolation) and from the conversations I’ve been having recently, recognise that many of you feel exactly the same.
I have spent four out of five days this week working out of both our London offices, in the City and West End, plus one day working from home. This feels like the new norm, or as it was described by the Lord Mayor of the City of London in a webinar that I hosted this week, the ‘repositioned normality’.
Having said that, I am amongst only about 10% of people who are currently coming into the centre of London to carry out their work. Most people seem happy to continue operating from home, perhaps until September. Other cities have seen a greater return to the workplace than this. In fact, one or two of our offices are now back at almost 100% of capacity, but those are countries that have been less impacted by COVID-19 than the UK. Certainly, our colleagues in the US are also largely operating from home.
So, the question here is what are the implications of this for the office markets across Europe? Whilst the investment market seems to be returning to some form of normality, at least for core stock, this has in part been driven by the ultra-low interest rate environment that exists at present.
Occupationally, things are slower though. Inevitably occupiers are taking their time to make decisions, and many are deciding to postpone such a critical business decision by undertaking short term extensions or utilising flexible space options. However, in the last couple of weeks, our Leasing teams have signed a number of market-boosting transactions that were agreed pre-lockdown. Some of these have been in markets where the emergence from lockdown has been slowest - in London, BP (19,000 sq m) and Baker McKenzie (14,000 sq m) and in Moscow, Tinkoff have a signed the largest ever private-sector deal (78,000 sq m).
I am hopeful that we will see a continued increase in activity from office occupiers as the year continues, even if a full return to previous levels might require an imminent vaccine.
The second quarter ended with a somewhat brighter investment outlook despite still clear headwinds, exemplified by the weakness of rent collection in certain sectors. That, however, was largely expected and confidence continues to slowly return with a more encouraging view on transactions and pipeline. Sentiment towards values has remained more cautious, with concern over rents and incentives.
Germany is still leading the way, but others are also seeing confidence edge higher, often where COVID-19 has had less impact and is hand-in-hand with measures to normalise their economies, with the Nordics and Central Europe gaining for example. London aside, the UK remains in a weaker position and Brexit uncertainty later this year will not help this.
For good or ill, meanwhile, structural changes are accelerating, with the collapse of retailers and retail property owners juxtaposed by increasing demand for logistics, residential and alternatives such as data centres. A lack of activity is, at the same time, holding back price discovery, leading to a two-tier market based on occupier risk. This will accelerate as occupier distress forces action.
Encouragingly, however, for those on the side lines the wait may soon be over. Actions are now being taken that will unlock opportunities as, for example, lenders make a move. In addition, the flow of sale-and-leasebacks increases. This will set the scene for more activity, albeit in a very polarised market.
Last week I spent my first couple of days back in the office in our European HQ in the City of London. It was surreal venturing back onto the train and the tube (wearing my mask), although what I expected to be a difficult journey was not - very few people on either form of public transport, so social distancing was easy. It was good to be back.
Whilst in the office, along with a few colleagues, thoughts turned to how long it will take us to get back to normal, given that there are obviously restrictions on the numbers of people that can occupy the office (currently we are at 25% in London, other cities in Europe are getting up to 50%). This will take time and potentially a vaccine. But where do we go after that? What are the implications for the office longer term? Will we see companies taking reduced floor space as more people will work from home? Will occupiers start to move towards a ‘hub-and-spoke’ model? Or will things just go back to the way we were pre-COVID?
This week we hosted a webinar for our clients, both investors and occupiers, to try and shed some light on this. It was led by our Global Head of Occupier Business Performance, Despina Katsikakis, and drew on our Experience Per Sq Ft (XSF) at Home survey, where we have had over 50,000 respondents. This column is too short to go into the detail (please listen to a recording here) but I am pleased to report that the office is far from dead! Yes, people are likely to want to continue to spend some of their working week at home, but the office will continue to be the place where people come together to collaborate, learn and meet. If anything, the office will be a part of a wider ecosystem of places that people choose to work from.
I am even more convinced of that having spent the last 12 weeks working 100% from home.
The logistics and industrial sector has been one of the winners coming out of the COVID-19 crisis. Supply levels were low in most core markets going into the lockdown, sometimes less than 2%. Add to this the fact that, for every $1 billion of additional e-commerce sales, the market must provide an additional 1.25 million sq ft of logistics space. It has also been the most resilient market in terms of rent collections over the last few months.
Global capital is therefore increasing its weighting towards logistics as a response to this. In terms of lockdown transactions, this was the most robust sector and it is therefore no wonder that activity in the investment market has picked up quickly since countries have started to return to work.
Current transactions that the team are working on are coming in at pre-COVID pricing levels, or even slightly higher. Core logistics deals are now well underway across all geographies in mainland Europe and larger transactions (up to €500m in Germany) are now being talked about.
Whilst we have some way to go, this year could see in excess of €30 billion transacted by year end, which would be close to a record year. However, questions remain as to how quickly value-add will come back and there is the threat of business failures later in the year which may cause an interruption to this upward trend. But at present, for many investors in this sector, it is a case of identifying the product that they want in a shallower bidder pool, rather than the COVID discount they desire.
I’ve previously discussed the ongoing debate that occupiers and investors alike are having with regards to the future of the workplace, once we get back to ‘normal’ in a post-vaccine world. Our extensive survey of many of our corporate clients - Experience per Sq Ft at Home (XSF@home) - has had over 40,000 respondents, a significant sample size by anyone’s standards.
The results of this survey show that 50% of people expect to work in the future through a combination of locations, be it home, office or third places. And occupiers will be addressing their portfolios accordingly. Expect to see a combination of core HQ style offices, more local community hubs and flexible locations, with the ability for companies to scale up and down their footprints.
However, at its heart the office will have a role to help leverage the new digital equality that has arisen as a result of the last couple of months. Whilst people report that remote collaboration has reduced the feeling of locational and structural hierarchy, they do feel there is a disconnect when it comes to company culture, team connection and learning.
Some commentators have stated that they see a significant reduction in the total requirement for office space. I do not believe this to be the case. Companies will provide different types of space in order to provide an exciting, collaborative, flexible work environment, potentially in diverse locations. However, at its heart I believe people will want to work face-to-face with other people, but potentially not every day of the week.
I wrote last week, below, about how our Asset Services teams are helping investors and occupiers alike to adjust to the gradual emergence of the business world in Europe from lockdown. Cushman & Wakefield has been leading the way in opening up all types of commercial real estate, from office complexes to shopping centres. Our Six Feet concept has been at the heart of our approach.
However, investors are already beginning to consider what the future will bring for their portfolios. This crisis will most likely lead to a new reality in the way we work, shop, live and play - landlords need to adapt to this. This is the first global pandemic of the 21st century and there will inevitably be a concern that more could follow. Crisis and risk management will become a much more central consideration than it has been to date and will therefore become part of lease negotiations in addition to management and operating concepts. Expect, therefore, these issues to be much higher up the agenda in any discussions between investors and occupiers.
More investors are realising the importance of good data in the current climate and the importance of digital solutions and connectivity. Business plans and capex projects based on the old world will have to be adjusted to ensure they can flexibly adapt to the new normal to ensure value-add solutions.
There is a lot to consider and adopt, which can be different for the various asset classes - but central to these changes will be technology, digital, behavioural analysis, contractual and risk management and customer experience.
I'd like to highlight the efforts of our Asset Services team in managing our clients’ properties so seamlessly during the COVID-19 crisis. Our Cushman & Wakefield colleagues on site have been on the front line, and we should not underestimate the risks that they have dealt with on a daily basis. Those working from home, in running these services, have done so with imagination and good humour.
Dealing with lockdown has meant looking at a range of different closure scenarios, and inevitably there was a strong focus on rent collection. Whether it has been rent abatement, lease renegotiations or other cost saving measures, these discussions between investor and occupier have needed to be dealt with skillfully and sensitively.
The built environment is now at varying stages of preparation for the return of workers, shoppers, students and visitors. Cushman & Wakefield’s management teams are helping people to do so with confidence. Across all industries, it is about the user’s ability to feel comfortable, safe and secure - this will be paramount to a swift business recovery.
Across Europe, we have been helping our investor clients to reopen buildings, whether they be offices, warehouses, shopping centres or other types of facilities, using the Six Feet concept. The response from owner and user alike has been positive.
However, the short-term return to work does not diminish the debate that is taking place about what long-term changes the current crisis will bring. These will be inevitable and the investors who react best to these changes will seize the day, as occupiers gravitate to those who provide the nimblest responses to shifts in market demand. I will cover this more next week, but for now a big thank you to every member of our Asset Services division.
With some of Cushman & Wakefield’s offices across Europe opening last week, and more planned during May, we are tentatively seeing our transactional business increase in activity. Not that things have been completely shut down - some deals have continued - however the pace of transactions has inevitably been slower.
For those countries that are behind on the path to reopening, there is some hope to come from Germany. Yes, Europe’s largest economy seems to have weathered the COVID-19 storm better than most, with significantly fewer deaths than all the larger Western European countries. However, the speed with which our transactional businesses have responded to the ‘end of lockdown’ has been extremely encouraging.
In fact, there were several investment deals that were agreed pre-COVID, which have now successfully completed. Significantly, we have new transactions now underway. In addition, our team in Germany is starting to take to market several significant sales mandates and initial indications of buyer interest are good. The level of capital available to many real estate investors, and particularly to the German funds, means that we are anticipating significant interest.
In addition, we are already seeing signs that leasing activity is starting to ramp up. All this gives us hope that the ‘engine of Europe’ is pointing the way for the rest of us to follow.
As I wrote last week, the debate amongst investors and occupiers is hotting up around what the longer-term impact on the office markets will be of the COVID-19 crisis. The response is, of course, led by the occupier. The world’s largest ‘Working from Home’ (WFH) experiment is deemed by many companies to have been a success, and a game-changer in how they will think about their offices after a vaccine is found and business returns to ‘normal’.
On one hand, some companies believe they will be able to operate in much less space, as they have a greater mix of agile working and WFH. And on the other, companies may decide they need to create more space for co-creation and social purposes. At the same time, we have the impact of our denser working environments. Will this be the signal for a longer-term move back to a more spread-out floor plate? This will be the case in the short term, but will it be a post-vaccine development as well?
There is also a view that some companies will seek to set up satellite offices outside the larger cities - places that their staff can go to without having the commute into town. I was reminded by my US colleagues of the post-9/11 movement by companies out of Manhattan, but within a few years many of the same companies had moved back into the city.
I believe that ultimately the ‘war for talent’ will mean that city centres will remain attractive locations in which to invest, although the gap between prime and secondary locations will widen.
The implications of these movements for the investor world could be profound, and we have started several projects with clients to examine their portfolios and assess how they will be impacted by these changes.
The last week has seen a significant debate starting about what the future of the workplace is going to look like. We all know that there are going to be two periods that need to be considered - the immediate return (Horizon 1), which is the opening up of offices once lockdowns are released, and the longer term pattern of work (Horizon 2) once a vaccine is in place and the world returns to normal (whatever normal may be).
The Horizon 1 debate is active and has significant implications for both landlords and tenants. Many companies are now using C&W’s Return to the Workplace guidelines, some involving the implementation of the Six Feet Office. These principles do not just apply to offices - this week we are opening two shopping centres in the Netherlands, and there will be more to follow across Europe.
The longer-term debate about Horizon 2 is just starting to warm up. There have been a number of CEOs who have stated that they see the landscape of their property portfolios changing in the mid-term. Views vary from “we are never going back to what we had before” to “we see no discernible change; in fact, we need to give more space to our people”. As ever, the reality will probably lie somewhere in between. One thing is for certain though - the changes outlined will require thought by all investors when considering their investment into commercial real estate.
Over the last couple of weeks, the debate has been turning increasingly to the ‘return to the workplace’. Investors are no different; the initial phase of lockdown was all about ‘securing the portfolio’ (which also meant discussing rent payments with tenants). But now across Europe the debate is about how best to reopen, as and when allowed by the Government.
Our ‘How to guide’, developed by Cushman & Wakefield’s Recovery Readiness Task Force, is the playbook that is now being followed by investors and occupiers alike. It is a guide to help businesses get back into the workplace in a safe way, and this is the predominant talking point amongst all our clients.
This will be managed in different ways by different companies and sectors. However, the debate is already starting to turn to what the future of the workplace will be like in the longer term. Will we see less dense office floorplates? Will the CBD of cities be less popular and regional or suburban centres increase in popularity? What is the longer-term impact of the great ‘working from home’ experiment? There is no consensus on this but the answers to all these questions will impact the shape of our cities to come and the commercial real estate landscape of the future.
Increasingly over the last couple of weeks my conversations with Investors have been turning to ‘what do we do when we are ready to return to work?’ There is a realisation that there will be a new norm for a while, until a vaccine is fully in play. And this norm could involve some very different working practices.
So, investors are inevitably asking what their own customers (the occupiers) are going to be doing. At Cushman & Wakefield we are leading that debate through our Recovery Readiness Task Force (RRTF). The RRTF this week launched our Recovery Readiness: A How-to Guide for Reopening Your Workplace. This 30-page guide to getting back to work will become integral to many of our clients as they seek to return to the office.
However, longer term, there are many questions that our clients are beginning to ask:
- Will the COVID-19 crisis mean a move away from less dense working environments, thus impacting design and construction of new office developments?
- Will some organisations move back to a more cellular working environment (as I heard from Germany this week)?
- Will organisations move to more of a hub-and-spoke occupational model, with the positive impact that this might have on out-of-town office markets?
Plenty of questions, and yet very little clarity, but at least we are starting to see some direction from certain countries on the timescales for getting back to work.
I've been pondering the changes that have taken place over the last few weeks of lockdown. My thoughts turn to what is likely to lead us out of the situation that the commercial real estate markets find themselves in, as a result of the current crisis.
As much as I am concerned with ensuring our investor clients have the best access to information and insight at this difficult time, it is apparent from the many conversations that I have had that investors are just as concerned over what the occupiers are going to do. It is the occupiers, after all, that pay the rent and whose covenant strength underpins any investment.
So, let me give some hope surrounding the strength of the leasing markets across Europe. Cushman & Wakefield is currently involved in over 4,000 leasing transactions across EMEA. Of these between 65% and 80% of those transactions are still ongoing (dependent on sector).
It is no surprise that smaller transactions have been most at risk and that the retail sector has seen the most fall out. However, less than 5% of transactions have been cancelled. The difference between these two numbers are the deals that have been ‘shelved’ or put on ice. Time will tell whether these will return to the table.
Given what is happening these numbers are encouraging. That is not to say that all the deals still being worked on will conclude, as much will depend on a successful return to work - take a look at the 6 Feet Office concept. However, they at least indicate that many occupiers are continuing in the expectation that some form of normality will return in due course.
It would be too simplistic to think that the investor response to the current crisis is dependent on which sector you are invested in.
Certainly, if you are deep into retail and hotels then you will be very concerned about the strength of your tenant base and how your rent collection held up at the end of the quarter.
However, those questions are still pertinent to holders of industrial and office stock, even if the former seems to be particularly busy at present ensuring they are keeping the vital supply lines open for essential goods and services.
So, management of your existing stock is more important than it has ever been, and our Asset Services teams are doing sterling work for our clients ensuring that things continue to run smoothly.
There have been key lessons to learn from our APAC business particularly around areas such as public health and tenant communication.
In the meantime, I can report that transactions are continuing – both sales and lettings. Existing transactions, many of which were in place pre-lockdown, are, by and large, still in place. On the occupational side this is particularly true at the larger end – smaller transactions have seen more fall out.
And so inevitably the focus turns to where the opportunity for investors might lie in this whole situation. I well remember the first movers coming out of the GFC – the ones that bought cheaply when others were still on the side-lines.
We are not anticipating the same reduction in values, particularly in a market where the fundamentals were strong going in and the level of capital to invest remains high.
Winners of the COVID-19 era will be the all-equity investors (debt finance is likely to remain weak) that see the bottom and are prepared to buy an asset before others see it.
Without any question the last few weeks, dependent on which country you are in, have been some of the most challenging in which to operate as a real estate investor.
Not only are you operating from home (thanks to video conferencing, group chat and webinars), but your portfolio is dealing with the realities of lockdown: offices are largely closed, retail is closed (unless its grocery or other essentials), logistics is working overtime to keep the supply chain open for those essentials, hospitality is closed, student housing is closed.
Of course the management of those premises continues, and our Asset Services team is on the ‘front line’ ensuring property management continues as well as managing the quarterly or monthly rent payments - and, any non-payments.
The implications spread far and wide - valuations are inevitably impacted, but where will the evidence be for these going forward if we have an extended lockdown and leasing transactions slow down?
Transactions presently in lawyers’ hands look as if they are proceeding. The pipeline for later in the year will be impacted, although technology will play a part as we undertake virtual viewings. New development or refurbishment construction is also impacted across many EMEA countries.
The investment market is being impacted to various degrees depending on the sector. There are plenty of existing transactions that do seem to be proceeding, albeit slower than before.
Interestingly there are investors now waiting on the sidelines, looking for the floor to appear, and ready to jump in. Globally there is over $300 billion available to commit to real estate, and in which real estate that is put will truly define the winners and losers of this crisis.