Offices might not reach pre-covid performance heights until 2025

Vacancy and rental levels could be on a longer-than-anticipated road to recovery, especially in western markets.

The latest recovery forecast for the office sector looks foreboding. In its Global Office Impact Study and Recovery Timing report, published in late September, property services firm Cushman & Wakefield forecasts that global office vacancy rates will only return to pre-crisis – that is, Q4 2019 – levels of approximately 11 percent by 2025. Cushman predicts that the crisis-inflicted recession, subsequent job losses and structural shifts in office demand will cause vacancy levels to decline to 15.6 percent in 2022, after which they will start improving.

Cushman’s outlook for rental growth is also gloomy. The report’s baseline scenario estimates global office rents will decline by as much as 10.9 percent peak-to-trough from Q2 2020 to Q1 2022. It says that they too will only revert to pre-covid levels by 2025.

Since March, offices have been a particularly thorny sector for real estate investors to handle. There are ever-growing questions about underwriting assets, given the uncertainty over future demand and the timing of a fully fledged return to the workplace. In its research, Cushman added a caveat about how its forecasts are based on information to hand today – information tinged by the “unprecedented level of uncertainty in today’s outlook”.

If leasing activity and rents – two major drivers of office performance – are not bouncing back to pre-pandemic levels for another five years, office investors should brace themselves for a long, sobering road to recovery.

By many counts, the west faces bigger disruptions and long-term structural changes to office demand than Asia-Pacific. The US and Europe have a more ageing labour force and have sustained more pronounced job losses since the outbreak. More crucially, Cushman’s report predicts that working from home – one of the biggest threats to the office sector’s recovery – will be less common across Asia-Pacific, especially in populous countries such as China and India. Permanent working from home, for example, is estimated to double from 5-6 percent pre-covid to 10-11 percent over the next 10 years in both the US and Europe. In contrast, it is projected to increase from just 2.6 percent to 5.2 percent in Asia-Pacific and from 0.6 percent to 1.2 percent in Greater China.

Data provider Real Capital Analytics reports that, in terms of investment flows, offices were therefore hit badly in Q2, during which there were $40 billion worth of transactions globally – a 57 percent fall year-on-year. The US continued to show muted deal activity, with only $2.7 billion in office transactions in August.

Although current fundamentals and transaction data do not paint an optimistic picture of one of real estate’s most institutionalised asset classes, analysing the office sector’s recovery path during previous cycles offers some hope.

Highlighting the “resiliency of office investment flows in global gateway markets”, broker Knight Frank noted in its Forecasting Capital Flows in 2021 report that demand for US office assets ended up recovering by Q3 2009 after the global financial crisis. The UK has also always remained in the top five destinations in terms of global cross-border capital during every quarter except for the two immediately before the GFC. Office transactions in France and Germany led the field in terms of cross-border capital when the market was recovering from the eurozone crisis.

It cannot go unmentioned, either, that office transactions of scale are still happening, and not all of them are being undertaken with opportunistic money. According to UK commercial property website React News, £3 billion (€3.3 billion) of offices deals are currently under offer in London alone.

Only once transaction activity fully resumes can the market conclusively determine how pricing has reset to factor in the latest projections of office fundamentals. Until then, and while recovery forecasts continue to stretch out, the big question mark over offices will remain.

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