In July we held our Global Recovery Journey webinar in which a panel of our investment and workplace experts explored the trajectory of global economic and commercial recovery around the world. To close the session, we held an audience Q&A which yielded outstanding discussion on a range of prescient topics. So interesting were the questions that we’ve asked our expert speakers to address some of those we couldn’t get to in the allotted time.
What do you foresee to be the most prevalent long-term change to the real estate industry as a result of the global pandemic?
Putting our heads together, we unsurprisingly came up with a range of views on what the long-term impacts might be, but with an overarching theme of measuring what we do and really using the data to manage the changes that are coming.
Our key thought on change itself was that we can expect a much greater emphasis on flexibility: both in how we approach work and use space but also in how we assess the fundamental need for change in the first place. For example, on one hand it can be daunting to acknowledge that we have been far too slow to change. However, we have proved during the pandemic that truly radical and rapid change is possible! Who knew productivity could be maintained with such high levels of home working? Who knew supply lines could cope with so many people shopping outside the shop? And perhaps most notably, who knew effective vaccines could be developed so quickly?
At the same time however, while we need improved efficiency, productivity and sustainability, many of our previous business practices remain successful and don’t need to change. Good real estate in good locations will generally remain good real estate. Hence, its fundamentally correct to start by asking “what doesn’t need to change” and not to overreact.
Indeed, as the French would say, the more things change, the more they stay the same. Our key challenge will be to integrate new thinking with the best of the old and to think the unthinkable, reaching for bold new solutions to how we build, manage and use space to answer the challenges we face today and to anticipate those of tomorrow.
How do you think the rise of omnichannel will impact retail & logistics going forward?
Globally, the evolution of omnichannel has considerably further to go as it increases in market share and we see more refinement in fulfilment and pricing models, for example around home delivery. Within this process, the merging of retail and logistics into one multi-faceted fulfilment model will only accelerate. However, such has been the repricing of these asset classes, particularly from a capital markets perspective, we are now approaching a point where the risk of change is priced into prime retail while conversely some logistics owners may be exposed to demanding rent forecasts.
In our view, in urban areas and strategic transport nodes at both ends of the supply chain, land supply and catchment sizes mean the profit potential of the right location does underpin significant upside for logistics rents. Equally however, the right retail, in the right mix of uses, will be in strong demand for fulfilment, browsing and leisure and will also generate competition and rental growth.
Indeed, that there is a need for physical retail space is not in doubt, whether from a brand value, business effectiveness or social needs perspective. What is in question is how different formats and locations will adapt to their new role. With a more demanding consumer and retailer, a hollowing out of the market will favour prime destinations and accessible convenience locations but success also relies on the right retail management system and logistics is both integral and critical to success.
As a result, while it is still too early to say what the future shape of the market will be, thanks to market repricing and the potential for innovative management, it is at least clear there are now opportunities as well as risks across the fulfilment spectrum, from sheds to shops.
Does lease contract structure explain why the U.S. has 'shed' more space than Europe?
We do not believe a difference in lease structure explains most of the discrepancy between the two regions’ fundamentals. There is a combination of factors as to why we may be observing a slower office demand response in European cities compared to their U.S. counterparts. First, it is possible that the way in which household income support was deployed during the pandemic played a role as each region responded differently. In the U.S., unemployment insurance schemes were largely the way in which households received income support payments. In Europe, this happened through wage subsidy schemes, keeping workers more intimately tied to their employers, possibly elevating certainty around the level of employment post-pandemic. Second, combined with more restrictive labour laws and the more frequent involvement of workers in decision-making (e.g., via workers’ councils), European businesses have been less reactive in shedding space.
Additionally, prior to the pandemic, vacancy rates across Europe were much lower with quality space in the market hard to find. Consider that in 2019 Q4, more than half (24 of 41) of European cities had a vacancy rate under 7% while the U.S. had a vacancy rate of 12.9% and only 11 out of 89 markets had a vacancy rate under 7%. With this backdrop, many companies have been reticent to offload space.
All of that said, in some European countries, such as Belgium and France, there is a 3/6/9 lease structure with more frequent breaks. Occupiers may wait and use these rather than seek to release/sublease space mid-term. We do not believe this accounts for a majority of the difference, though.
How much of the recovery is catch-up from the lockdowns, and how much do you believe is a longer-term trend?
Much of the recovery, and now expansion in the case of the U.S., is being propelled by both the reversal of lockdowns/re-openings as well as fiscal stimulus, whose effects will wear off over a period of several years. In the U.S., fiscal stimulus equates to 25% of pre-pandemic GDP, and stimulus throughout Europe exceeded 10% in multiple countries: the UK (16%), Italy (12.1%) France (11.5%) and Germany (10.1%). These figures do not even include the liquidity support offered through central banks or other credit interventions.
Long-term, we expect real U.S. economic growth to revert towards its potential growth rate, which remains in the 1.7% to 2% range, and for European growth to do the same (with its potential growth rate in the 1.1% to 1.4% range). We will see some structural changes continue, both those that were occurring pre-pandemic—such as e-commerce growing rapidly and other technological disruptions—and those that emerged as a result of the pandemic—such as a transition of supply chains towards more “just in case” from “just in time.” These structural shifts have not fundamentally altered estimates of these economies’ underlying potential growth rate.
What impact is the push to work from home having on global aggregate demand for office space?
It is important to note that there is still a lot of uncertainty around the work from home (WFH) dynamic and how it will play out, particularly at a regional level. For example, in emerging countries throughout Asia Pacific and Greater China, there is not expected to be a major shift to WFH for a variety of reasons. Indeed, demand for office space was positive in 2020 and has accelerated so far in 2021 in those areas. Throughout advanced economies, we expect flexible working, including the ability to WFH, to become more common and create a marginal drag on demand. Said differently, for every new office job, we get slightly less demand in the aggregate. This effect will impact the market gradually given the longer-term nature of office leases. Much of what is being recorded right now is tied to the economic downtown last year as well as an elevated level of uncertainty.
However, economic activity creates demand for all kinds of jobs, and historically—especially in modern history—this has meant that knowledge and office-using workers are needed at higher rates. Thus, office-using employment has accounted for an outsize share of job gains (relative to its share of total employment) and that trend is expected to remain. This factor is an offset to the WFH drag and is one reason that we anticipate that office property markets will make a full recovery despite WFH. We investigated this question in our From Pandemic to Performance series last fall, and continue to emphasize that the situation is evolving and there are still a lot of unknowns.
Next week check back for answers to questions addressing the changing nature of the workplace as we head through the recovery. For insights on all things related to the pandemic recovery, visit our dedicated pages here.