Nick Waring, development director at PineBridge Benson Elliot, explains the investment manager’s take on offices and why things could be worse…we could be in the US.
'It is not a good time to speak to US investors about offices.
Whereas in Europe the average vacancy rate across building classes seems to be settling out at about 7% (two percentage points above its pre-pandemic levels), in the US it has soared past 20%, with some markets like San Francisco eclipsing 25%. Some 7% of all US office buildings now sit more than half empty.
One difference between the two markets are longer and more expensive commutes in the US that have left the rate of office re-entry at about 50%, compared to 70% on average across Europe. But there are also key differences on the supply side, namely related to the vast inventory of office space erected in the US over the past decade-and-a-half of cheap financing.
In Europe, the amount of space constructed during the free-money years was never as large as it was in the US. Building codes were tighter, available land, especially in or near city centres, always much scarcer. As a result, a higher percentage of the properties either in or moving toward obsolescence have a shot at getting rebuilt.
A “shot” because the bar for what constitutes desirable, and therefore leasable, space in prime European city centres has definitely been raised. How much? It is important to consider three factors.
It is common knowledge that European corporate tenants now want smaller “destination” office spaces. What’s less known is just how much flexibility some of these tenants are demanding. As many tenants still don’t know (or have stopped trying to figure out) how hybrid arrangements will continue to evolve, let alone where the economy is headed, they have begun treating their tangible space more in the fashion of their virtual office and other software and equipment licenses—i.e., programmed to be updated over time.
For property owners, those capable of benefitting from the pricing power such arrangements can provide to offset cap-ex burn should find the most success: strong locational advantages, as always, will be key to making the new dynamic work.
Go green or go home
With 40% of annual global CO2 emissions come from the operation of buildings and their construction, prime tenants the world over are realizing they can’t meet their net zero goals without choosing to lease designated-green office space.
The difference in Europe, where net zero targets are more aggressive, is that the standards for what exactly constitutes green are that much higher. This, in turn, has created some pretty significant supply-demand imbalances. How significant? For a certain small but growing segment of tenants, only credentialed BREEAM Outstanding will do. But in the entire city of London, six properties are currently designated BREEAM Outstanding.
Post-pandemic, healthier, less crowded, more naturally lit spaces with better air circulation and open stairwells to discourage lift crowding have become table stakes. In particular we have seen strong demand for “biophilic” offices, based on the principle that humans are biologically wired to seek a connection to nature. In architecture this has given rise to extensive use of natural light, thoughtful landscaping, indoor greenery, and other organic elements.
The new business circle
Property owners must now also be prepared, as office needs keep evolving to in a decade or so’s time, to be able to refurbish, or even demolish, buildings with as near-zero environmental impact as possible.
Many firms are working with sustainable building material manufacturers to make the circular economy a reality. Increasingly, many are exploring circularity with design and materials that make buildings more destructible with the hope that they can ultimately be reused once the building becomes obsolete instead of going into landfills.
This approach prevents further production of embodied carbon in the manufacture of building materials. The bespoke nature of buildings makes this a big challenge. However, it’s a journey many have embarked on, with a view to alternatives future uses within the fabric of the buildings designed.
In summary, for property owners and investors with a chance to compete for relevancy in the post-pandemic, post-rate-normalized, net-zero-or-bust European office market, meeting the bar of the new more flexible, greener, healthier, more recyclable definition of prime is no walk in the park. But it could be worse. They could be in the US.'
