Is the death of the office real?

An article in The Economist from April 2020 asks not just about the death of the office at the pandemic's outset but what the point of an office was, to begin with. Part of the article suggests that “the most transformative aspect of offices was less the buildings themselves than the sheer amount of time we spent in them.”

And while the 'death' of something makes for a great headline, office vacancy rates are elevated but not in an irreversible downward spiral - as Colin Mackay of Cromwell Property Group explains:

"The market will resolve that over time. We'll see reduced levels of new supply and Australia continues to have really strong population growth which will help fulfil demand going forward," Mackay said.

After all, office utilisation in Australia is at 75%, a far higher average than in the US and in other comparable markets. 

But there is no doubt that COVID has changed the priorities of office workers - and it is also changing the composition of which companies are occupying office-style properties.

In this episode of The Pitch, Mackay joins me to discuss the evolving landscape for office investments and what the changes mean for your portfolio.

EDITED TRANSCRIPT

Hans Lee: Is the death of the traditional office real?

Colin Mackay: Short answer, no. But the headline grabs plenty of attention. In reality, it doesn't paint a full picture of what's happening on the ground. We have seen a pullback in demand and that's seen office vacancy rates become elevated. But the market will resolve that over time. We'll see reduced levels of new supply and Australia continues to have really strong population growth which is a fillip for demand going forward. 

I think it's important to remember that people were calling the death of retail six years ago, and we've still got shopping centres. That hasn't happened. 

What has happened is there has been a greater bifurcation in performance between the top quartile performers and the bottom quartile performers. There have been changes in the way shopping centres are managed. 

I think we'll see similar trends play out in the office market. The assets that tick all the boxes will continue to do quite well and they'll outperform the assets that are missing a piece of the puzzle.

Lee: What has brought about the change we’ve seen in recent years?

Mackay: The big driver has been the greater prevalence of working from home. It existed before the pandemic, but not to the extent it exists now. I don't think we're going to go back to five days a week in the office, because having greater flexibility is good from a diversity and inclusion perspective.

We're seeing record levels of labour force participation, and it also improves employee engagement, and employee retention, and that can be good for businesses too. 

Ultimately, I think the key is balance. And for most roles, and most organisations, that's a mixture of some time in the office and some time not in the office.

Lee: Is this trend impacting all parts of the market in the same way or are there differences?

Mackay: We're definitely seeing differences across geography, industries, and occupier types. On the geography side of things, if you look at a market like the US, where a lot of the negativity originates, office utilisation is about 55% of pre-COVID levels. If you look at Australia, we're at about 75%, so you're already dealing with a very different kind of demand profile. 

Even within Australia, a market like Perth is at 90% of pre-COVID levels, while Melbourne, which had a more intense pandemic experience, has lower office utilisation. 

From an industry perspective, we've certainly seen professional and financial services pull back their office footprint a bit. But we've seen the public sector and we've seen blue-collar industries actually expanding their footprint. But the biggest trend we've been seeing is on the occupier side of things, and that's much stronger demand from smaller occupiers.

Lee: Are there risks involved in catering to the influx of small business occupiers?

Mackay: I think it's a bit of a misnomer. The common detractor or disadvantage is that they're more likely to go bankrupt or they're going to stop paying the rent. But if you look at the data, it's not really the case. 

Lee: How do all these geographic, industry, and occupier-type changes affect where you are finding opportunities?

Mackay: Ultimately, working from home is the big trend and it's impacting demand. Real estate is largely a function of supply versus demand, so you really need to understand how those work-from-home space impacts have been priced in. If space is yet to be handed back, how easily and effectively can you re-lease that space back to the market? 

And understanding that requires deep knowledge of the asset, the micro-location, the leasing market,- and how well that asset stands in a time of evolving occupier needs.

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