Commercial real estate faces the same fate as retail

Commercial real estate faces the same fate as retail

A lasting shift in consumer behavior, an industry prone to denial, growing gloom and the possibility that things could get even worse.

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

The structural change is also biting. The pandemic-induced transition to hybrid working continues, 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.

First, a trend can take a long time to hurt. Looking back, the expansion of retail space in the UK after the arrival of smartphones in 2008 seems insane: total space grew by around 10% over the next decade, according to officers Lambert Smith Hampton. Even as the online share of retail grew, logistics demand soared and retailer failures multiplied, so physical growth continued, seemingly justified by the “halo” effect of new stores or omnichannel strategies. Once vacancy rates began to rise significantly, it was too late: Real estate agent Savills said up to 300 million square feet, or a quarter of the market, could be surplus to current needs by 2030.

Office owners need not worry about the disappearance of multi-site tenants, or at least not with the frequency of retailers in recent years. But after suggestions that the bosses or the young or the ambitious would lead the return to the office, followed by predictions that hot weather, cold weather or economic pressure would force a revival, the shift to working from home looks here to stay. . Occupancy rates are about half of pre-pandemic levels, or around 30%, according to Remit Consulting.

It takes time to feed the market as leases expire. LSH’s research this summer found that three-quarters of occupants said they plan to shrink space when they can, based on a stable headcount, with the most popular option being a downsizing including between a fifth and 40%.

This brings us to another echo: “Forking” is the industry’s best friend. Despite an increase in vacancy rates since 2020, particularly in the City, office agents are reporting robust rental figures, with most rentals targeting the newest and most durable 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 industry jargon, will be fine. In retail, after years of similar claims, this was not the case: premium malls may have cracked last and recovered first, but everyone suffered, says Peter Papadakos of Green Street Advisors, which predicts a 15% decline in office demand. hybrid work since mid-2020. Rot from one part of the market can seep into the other.

According to RICS, expectations for the capital value of prime offices next year have fallen from the second quarter to the third quarter of this year, while the previously strong rental outlook has been reduced to modest growth.

The real danger now is how a structural shift in what tenants expect from office space interacts with a cyclical downturn. Retail suffered not only because of online commerce, but also because rents were too high in relation to turnover, two problems which were then supercharged by the pandemic.

The office market does not have the same affordability problem; occupancy bills are perhaps 15% of overall operating expenses and are much lower relative to staff costs than in retail. But that makes prospects for job growth critical, affecting tenants’ willingness to keep excess acreage just in case or move to more sophisticated digs near cafes or bars, particularly if the battle to attract staff diminishes. Subletting is the first sign of trouble as companies hedge their bets in the face of a recession of uncertain depth and duration.

Whether retail rumors in the office market will intensify will depend as much on employment numbers as square footage.

helen.thomas@ft.com
@helentbiz

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