Slouch

• Corporates are mandating RTO protocols, whilst governments are reasserting WFH mandates
• Investors are selling offices whilst also maintaining now is the time to buy
• Offices rank as one of the top asset classes in Investec report
• London recorded the second-lowest office attendance 

The dynamics of office demand are increasingly complex in a post-pandemic world, with companies reassessing their need for space as hybrid and remote work models become more prevalent. Thus, future proofing a business with respect to office utilisation is tricky. In a recent podcast, David Rubenstein reflected on his initial goals for Carlyle, explaining that he never aspired to have a large company, telling a leasing agent, "I'm going to start a 10 person firm. The most we will be is 10 people." Despite being offered a free option for an additional 5,000 square feet of office space, he declined, stating, "I don't want to be tempted to grow", but now, Carlyle has "hundreds of thousands of square feet," though much of it is unused since "nobody shows up anymore because everybody's working at home." Clearly business success is fateful, and planning for office requirement has become more complex still since the pandemic. 

This conflicting signals is evident in British Land's 'campus' office complexes, which declined in value by 5.3% over the year to March 2024, albeit at a slower rate. CEO Simon Carter contrasted the fall in value with occupancy levels on Tuesdays to Thursdays which are now at or above pre-pandemic levels. Despite this improvement, British Land has been reshaping its property portfolio by divesting stakes in some London office complexes, such as those at Euston and Paddington. The company announced that it would consider bringing in a new investor for its planned tower project in Broadgate, which recently secured a pre-let from U.S. hedge fund Citadel. Despite the drag on valuations from offices, British Land said demand for high-quality central London space was strong with occupancy on Tuesdays-Thursdays up to or above pre-pandemic levels..

Other investors may be ready to step up to meet this demand, as Savills has identified signs of improvement in the European office investment market. Although investment volumes remained subdued in the first half of 2024, several jurisdictions showed year-on-year growth.

The surplus of office space continues to weigh on the market. According to the 2024 CBRE European Office Occupier Survey, 57% of European businesses plan to reduce their office portfolios over the next three years. However, more than half of the respondents indicated they would renew leases for properties deemed "fit for purpose," with landlords increasingly open to negotiating lease terms.

Future occupier demand could be boosted as companies increasingly offer incentives to encourage staff to return to the office. According to The Centre for Cities, 81% of UK chief executives surveyed are now willing to offer such incentives, a significant rise from 56% in 2023.

These incentives may be particularly needed in London, which recorded the second-lowest office attendance among six surveyed cities, with full-time staff averaging just 2.7 days a week in the office during spring 2024, up from 2.2 days the previous year. This still lags behind cities like New York, with an average of 3.1 days, and Paris, which leads globally at 3.5 days. Indeed, Business Secretary Jonathan Reynolds said the following in a recent interview “… I would say that every piece of evidence that has ever been collated suggests that flexibility, when agreed between employer and employee, is good for productivity and is good for staff resilience. You get to retain your staff for longer, you get more out of them.” Work from home has become ersatz government policy.

One major factor contributing to London's lower attendance is the cost of commuting, with over 40% of London workers citing travel savings as a key reason for working from home. The think tank suggested that employers consider redirecting funds from office refurbishments and perks towards subsidising commuting costs, similar to the legal requirements for Parisian employers.

The "stick" approach could also prove effective, as the Centre for Cities found that employers in all surveyed cities, including London, could impose stricter office mandates without risking significant staff losses. In London, fewer than one in ten workers indicated they would look for another job if required to come to the office more regularly, despite nearly 40% of employers fearing that such mandates might lead to staff quitting.

Company attendance policies are starting to reflect this data. It was widely reported that PwC has notified its 26,000 UK employees that it will start tracking office attendance in the same way it monitors chargeable hours, as part of a move towards a stricter hybrid working policy. Employees are now required to spend “a minimum of three days a week” in the office or at client sites.

In a similar shift, it was also reported that Amazon has instructed its staff to return to the office five days a week starting next year, representing one of the strictest corporate crackdowns on remote working since the pandemic. “We’ve decided that we’re going to return to being in the office the way we were before the onset of Covid,” Amazon CEO Andy Jassy wrote in a global memo to employees. He elaborated, “We’ve observed that it’s easier for our teammates to learn, model, practice, and strengthen our culture; collaborating, brainstorming, and inventing are simpler and more effective.” Jassy further emphasized, “The advantages of being together in the office are significant. The last 15 months… has strengthened our conviction about the benefits.” Criticism over this corporate “echo chamber” has come from noteworthy places, including New York Times bestselling author Brigid Schulte in her book ‘Over Work: Transforming the Daily Grind in the Quest for a Better Life’. Some employees, she argues, can actually demonstrate improved productivity to their CEO, but “can’t get them to listen because instead they’re listening to their fellow CEOs”. Bosses flex return to office mandates to signal muscular leadership.

Office agents appear to believe that the combination of reducing surplus space and a gradual return to the office has shifted the balance of demand and supply into slightly positive territory. According to the RICS Quarterly Market Monitor, for the first time since 2022, a net positive percentage of respondents (4%) anticipated that office rents would increase. Indeed, anecdotal evidence from industry insiders have tantalized the prospects of some big rents being signed across European cities. 

If occupier demand improves, investment demand is likely to follow suit. Cushman & Wakefield reports that although Central London office investment is expected to see notably low volumes in the third quarter there has been a significant increase in the number of buildings under offer. As of 1 June, £700m was under offer across Central London, but by 10 September, this figure had more than doubled to £1.54bn. Martin Lay remarked, “That is a strong indicator of what we expect to be an active Q4. Some of those deals will close before the year ends, giving us a clearer sense of the market.”

A growing source of capital may be coming from the private sector, with offices ranking as the third-most appealing asset class in Investec’s second Future Property survey. The survey, which included 110 high-net-worth individuals and entrepreneurs with a combined net worth exceeding £6bn who are actively developing or investing in UK real estate, highlights this trend. Shivani Goolab, head of private client real estate at Investec, remarked, “Reflecting the value-add expertise of this cohort, the report reveals a major bounce back for the office sector and the growing opportunity for development – in particular, the repurposing of older office assets.”

Lenders too are paying heed. Ardian's Sandrine Amsili is confident that grade A offices in prime central locations, with top-tier environmental certifications and services, remain highly desirable and will continue to attract tenants. “We see that in the numbers,” she states in an interview with Green Street News, noting that these assets will also maintain their appeal to Limited Partners (LPs). However, Amsili emphasizes that success “really depends on the location.” She observes that pure construction projects are increasingly rare due to limited development opportunities in central locations, particularly in the gateway cities of continental Europe, where land is scarce. Instead, the trend is shifting toward major refurbishment or ambitious renovation projects. “What we see are heavy refurbishment works or very ambitious renovations,” Amsili explains. These often involve financing acquisitions alongside capital expenditure projects to upgrade a building’s technical features and ensure it meets modern environmental standards.

An improvement in the office market is urgently needed to prevent potential contagion in the U.S. with plunging office values raising alarm in Washington. According to POLITICO, a New York lawmaker described the situation as a “ticking time bomb” for banks, with nearly $1tn in commercial real estate loans coming due this year. Confronted with vacant office buildings and a housing shortage affecting millions, a bipartisan group of lawmakers is working to make it easier for developers to convert underused office properties into residential housing. “This would absolutely help lenders recoup some of their investment while allowing them to align with the current needs of the market,” said Mike Carey, who introduced a bill this summer proposing a temporary 20% tax credit for qualified property conversion expenditures. Carey, who co-sponsored the bill with Jimmy Gomez, noted, “The pandemic caused a seismic shift in work patterns… We see these vacant office buildings as a well of untapped potential.” New York state lawmakers are also addressing the issue by encouraging office-to-housing conversions. Developers in New York City who set aside a quarter of an office conversion’s units for affordable housing can qualify for a 90% tax abatement, offering further incentives to repurpose underutilized office space.

Historian of medicine and disability at the University of Pennsylvania, Beth Linker, writes in her latest book ‘Slouch: Posture Panic In Modern America’ that at the turn of the century “Americans were told that they were living through a poor posture epidemic that, if left unchecked, would lead to widespread illness, disability, and even death.” Posture science has been largely debunked, but Linker notes that some aspects have resurfaced in the 21st-century “wellness” rebrand. The Covid-19 pandemic, and all its implications, has led us to think more about how we sit: companies spent a fortune on ensuring posture-friendly desk set-ups for office workers stuck at home during lockdowns and in standing desks for those returning to the offices. Just as our postures in the office have been addressed, so to must our posture towards the office market. The signals for some office investments are flashing green, yet the market reaction has been tepid. There is a window of opportunity to acquire and lend against well-priced, well-let grade A offices that are fully EPC-compliant, ESG-driven, and energy efficient. It’s time for less armchair prognostication and more decisiveness.