Commercial real estate faces similar reckoning to retail

Permanent change in consumer behavior, a sector prone to denial, a growing sense of gloom, and the possibility that everything could get worse.

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

Structural change is also stinging. The pandemic-induced shift towards hybrid working is continuing, leading to a decline in demand for office space similar to the rise of online retail for brick-and-mortar stores. The two sectors are certainly different – but there are echoes.

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First, a trend can take time to hurt. In hindsight, the expansion of UK retail space after the arrival of smartphones in 2008 seems insane: total space grew by around 10 per cent over the next decade, according to clerk Lambert Smith-Hampton. Even as the share of online retail has increased, demand for logistics has risen and retailer failures have increased, so physical growth has continued, apparently justified by the “halo” effect of new stores or omnichannel strategies. Once vacancy rates started to rise measurably, it was too late: real estate agent Savills said as much as 300m square feet, or a quarter of the market, could be surplus to requirements by 2030.

Office owners don’t have to worry about multi-location tenants fading away, or at least not with the frequency of retailers in recent years. But after suggestions that young or ambitious bosses would drive the office’s return, followed by predictions that hot weather, cold weather, or economic stress would force a revival, the shift toward homework seems to linger. Occupancy rates are about half of pre-pandemic levels, or about 30 percent, according to Remit Consulting.

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It takes time to get it to market as leases expire. LSH research this summer found that three-quarters of occupiers said they plan to reduce space when they can, based on stable headcount, with a cut between five and 40 per cent the most popular option.

This brings us to another echo: ‘Fork’ is a strip’s best friend. Although vacancy rates have increased since 2020, particularly in the city, office agents report strong rental numbers, with most rents seeking the newest and 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 employees might actually like.

Prime, in industry parlance, will be just fine. In retail, after years of similar claims, that wasn’t the case: high-end malls may have cracked last and recovered first but everyone else suffered, says Peter Papadakos of Green Street Advisors, who forecast desktop demand to rise by 15 per cent. . From the hybrid business since the middle of 2020. Mold in one part of the market could seep into the other.

Forecasts for key office capital values ​​next year followed secondary into negative territory between the second and third quarters of this year, according to RICS, while previously strong rental forecasts were downgraded to modest growth.

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The real danger now is how structural change in what tenants want from office space will interact with the cyclical downturn. Retailing suffered not only because of the internet but because rents were too high relative to sales volume, both problems that then caused the pandemic.

The office market doesn’t have the same affordability problem; Occupancy bills are probably 15 percent of total operating expenses and much lower compared to personnel costs compared to retail. But that makes job growth projections critical, affecting tenants’ willingness to carry excess square footage just in case or to upgrade to fancier digs near cafes or bars, especially if the battle for staffing eases. Subleasing is the first sign of trouble, as companies hedge their bets when faced with a recession of uncertain depth and duration.

Whether the retail hustle and bustle of the office market is higher will be determined by employment numbers as much as by square feet.

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