Commercial real estate is settled in the same way as retail

Commercial real estate is settled in the same way as retail

A lasting change in consumer behavior, an industry in denial, a growing sense of gloom and the possibility that things could get even worse.

Not retail for a change, but the British office market. Rising borrowing costs mean a correction is underway in commercial property, with the UK’s largest listed landlords reporting falling values ​​this month.

Structural change is also corrosive. The pandemic-driven shift to hybrid working continues, leading to a drop in demand for office space, similar to the rise of online stores to brick-and-mortar stores. The two sectors are certainly different, but there are echoes.

First, it can take a while for a trend to hurt. In retrospect, the expansion of retail space in the UK after the advent of smartphones in 2008 looks insane: the total space grew by about 10 percent over the next decade, according to agents Lambert Smith Hampton. Even as the online share of retail increased, demand for logistics skyrocketed, and retailer failures increased, physical growth continued, apparently justified by the “halo” effect of new stores or omnichannel strategies. Once vacancy rates started to rise significantly, it was too late: real estate agent Savills has said that as much as 300 million square feet, or a quarter of the market, could be redundant by 2030.

Office landlords don’t have to worry about multi-location tenants simply disappearing, or at least not with the frequency that retailers have faced in recent years. But after suggestions that bosses or youth or ambitious would lead the office return, followed by predictions that warm weather, or cold weather, or economic pressures would force an uptick, the shift to working from home seems to be holding. According to Remit Consulting, the occupancy rate is about half its pre-pandemic level, or about 30 percent.

That takes time to get to market when leases expire. Research from LSH this summer found three-quarters of occupiers said they planned to reduce space when they could, based on a stable workforce, with the most popular option being a reduction of between one-fifth and 40 percent.

Which brings us to another echo: “bifurcation” is the industry’s best friend. Despite an increase in vacancy since 2020, particularly in the City, office brokers point to robust rental figures, with most rental companies looking for the newest, most sustainable office space. Tenants are willing to pay more for less space, they say, but in a better location and in a building their staff might like.

Prime, in the industry jargon, will be fine. In retail, after years of similar claims, that wasn’t the case: Top quality malls may have been the last to crack and the first to recover, but everyone suffered, says Peter Papadakos of Green Street Advisors, who reported a 15 percent drop for retail. office demand has predicted from hybrid working since mid-2020. The rot in one part of the market can seep into the other.

According to the RICS, expectations for the capital value of prime offices in the next year followed secondary to negative territory between the second and third quarters of this year, while the previously strong rental outlook was reduced to modest growth.

The real danger now is how a structural change in what tenants want from office space interacts with a cyclical downturn. Retailers suffered not only from online, but also from rents being too high relative to sales, both of which were subsequently exacerbated by the pandemic.

The office market does not have the same affordability problem; operating costs are perhaps 15 percent of total operating costs and much lower relative to personnel costs than retail. But that makes job growth prospects critical, impacting tenants’ willingness to take excess square footage with them just in case, or upgrade to more luxurious rooms close to cafes or bars, especially if the battle for attracting staff decreases. Subletting is the first sign of trouble as companies hedge their bets when faced with a recession of uncertain depth and duration.

Whether the retail rumble in the office market gets louder will be determined as much by employment numbers as by square footage.

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