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Commercial real estate faces similar reckoning to retail

by Ozva Admin

A lasting shift in consumer behavior, an industry prone to denial, a growing sense of pessimism, and the possibility that everything could get worse.

Not retail, for a change, but the UK office market. High borrowing costs mean a commercial real estate correction is underway, with the largest listed UK landlords reporting declining values ​​this month.

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

First, a trend can take time to do damage. In hindsight, the expansion of retail space in the UK after the advent of smartphones in 2008 seems crazy: total space grew by around 10 per cent over the next decade, according to agents Lambert Smith Hampton. Even as online retail share increased, logistics demand skyrocketed, and retailer failures increased, so physical growth continued, apparently justified by the “halo” effect of new stores or strategies. omnichannel. Once vacancy rates started to rise significantly, it was too late: estate agent Savills has said as much as 300 million square feetor a quarter of the market, could exceed the requirements by 2030.

Office owners don’t have to worry about multi-location tenants just disappearing, or at least not as often as retailers have in recent years. But after suggestions that the bosses, the young, or the ambitious would lead a return to the office, followed by predictions that hot weather, cold weather, or economic pressure would force a resurgence, the shift toward working from home seems to have come to stay. Occupancy rates are about half of pre-pandemic levels, or about 30 percent, according to Remit Consulting.

That takes time to feed the market as leases expire. LSH rresearch this summer found that three-quarters of occupants said they planned to reduce space when they could, based on a stable workforce, with a reduction of between one-fifth and 40 percent being the most popular option.

That brings us to another echo: the “fork” is the industry’s best friend. Despite an increase in vacancy rates since 2020, particularly in the city, office agents are pointing to strong leasing numbers, with most leases looking for the newest, 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 staff might really like.

Prime, in industry jargon, will be fine. In retail, after years of similar claims, this was not the case: high-end malls may have gone bust last and recovered first, but they all suffered, says Peter Papadakos of Green Street Advisors, who has forecast a hit of 15 percent in the demand for offices. of hybrid labor since mid-2020. The rot in one part of the market may seep into the other.

Expectations for front office capital values ​​in the coming year followed the secondary into negative territory between the second and third quarters of this year, according to RICS, while a previously strong rental outlook narrowed to modest growth. .

The real danger now is how a structural change in what tenants want from office space interacts with a cyclical downturn. Retail suffered not only from selling online, but also because rents were too high relative to turnover, both problems later exacerbated by the pandemic.

The office market does not have the same affordability problem; Occupancy bills are perhaps 15 percent of total operating expenses and much smaller relative to staff costs than in retail. But that makes the outlook for job growth critical, affecting renters’ willingness to carry excess square footage just in case or upgrade to fancier digs near coffee shops or bars, particularly if the struggle to attracting staff is alleviated. the sublet is the first sign of troubleas companies hedge their bets when faced with a recession of uncertain depth and duration.

Whether retail noises in the office market get louder will depend on both employment numbers and square footage.

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