Why’s the office market struggling so much?

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I operate in the commercial office market, and I won’t lie, recent times have been challenging. There are a number of reasons for this, so I wanted to just dig into it a little bit and take a look at what’s been causing these issues.

If you’re looking to make an investment decision, it’s difficult when things are in such flux and so I’m going to outline what I’m seeing at the moment and what my colleagues and I have been struggling with.

Rising interest rates

The first issue is the rise in interest rates. Not only has it cooled the market a little bit, but it’s also pushed up quarterly payments, so they’re now much higher than they were even just a year ago.

What’s worse is that at the same time, the interest rate hike has cooled the technology market and world, which is causing a lot of big businesses to lay people off. When they do that, naturally they need less space and so they’re not renting the same size units they would have before. If (or when) they have excess space, now you see companies trying to find someone to rent that space from them, which is creating wider problems for the market.

Two types of space

It’s important to understand the two types of space that come onto the rental market, so I’ll briefly explain it here.

Firstly, you have official vacancy space, which is when a landlord gets the office back from the tenant (either at the end of the lease or from the tenant exercising their break clause). When the lease comes to an end the space officially goes back into the landlord’s hands for it to go back on the market to find a new tenant.

At the same time, when big organisations (eg Facebook or LinkedIn) lease space, they’re then committed to huge offices with equally huge rents (we’re talking millions per year). If they then find that they have space that’s surplus to their needs, which could happen for a number of reasons, but they’re still committed to it in the longterm, they may then put it back on the market to rent.  

We call this grey space: it’s not officially vacant space because it has a tenant, but that tenant has now put it on the market to sublet to somebody else.

So, at the moment we have vacant space from the landlords and grey space from the tenants competing with one another, which is a big problem: landlords are trying to preserve values, whilst the occupiers are trying to offload the grey space and aren’t concerned with preserving value, they only want to reduce their costs.

Post-Covid shockwaves

The second thing causing a challenge is the post-Covid workplace. During the pandemic lockdowns, everyone really got hybrid working figured out, and that means that now employers have gotten used to not having a full workforce in every day. So now companies will rent an office, but don’t have everyone onsite all the time. Whereas staff used to be in full time, now they’re coming in for maybe three (and in some cases only two) days a week.

That means these guys have got surplus space for only some of the week, and don’t know what to do with that occasional vacant space. So they’re reconfiguring the office and moving people to (for example) hot desks, meaning that a lot of people are only coming in midweek, and working from home on Mondays and Fridays.

That seems to be the new normal, and you certainly see it on the roads with far more traffic in the middle of the week! It can create problems though with offices either being empty, or overcrowded.

What this means for the office market is that nobody is really prepared to make any big leasing commitments, because they don’t know how much space they’re going to need in the coming years. If you’re a big employer and you’re signing a lease on an office building, you’re usually looking at a 10-15 year commitment, which, when there’s such uncertainty, they’re just not willing to do.

Environmental concerns

The final issue that we’re really struggling with is ESG and sustainability: it’s something I’m passionate about but it’s also something that I’m still learning all the time, because the industry is in a great deal of flux about all this.

In the past, if you had an older building in your portfolio, you’d want to bring it up to a certain standard to make it easier to rent out, despite being in competition with brand new buildings. These new buildings may achieve a higher rent, but something older will always be an option for companies that don’t want to pay so much.

They still have certain needs though, which until recently were to do with the energy performance of the building. There are a number of different certifications that you can give a building, based on (for example) the number of PV cells in the roof, the emissions that your building gives off, and how much water is conserved. On top of that you have (in the Irish Market) you have the BER, the Building Energy Rating, which in the UK Market is the EPC – the Energy Performance Certificate.

Those are typically measured on a scale of A-G, so if your house is really old it’s probably going to be lower down in the scale, whereas brand new buildings are all A rated. We have a building in our portfolio that is currently either D or a C, and we need to bring that up either to a B or an A, and we’ve been trying to decide which one is most appropriate. There’s an argument to be made for not going the whole hog on your refurb, because you may not be able to rent it out, even if you upgrade everything to an A.

Old vs New?

Further adding to the confusion, I was recently reading about the NZEB Standard – that’s the Nearly Zero Energy Building Standard. This is all about reducing your carbon footprint, but it’s not at all straightforward. You might have a building that’s got the highest rating for sustainability, however because of the amount of energy required to actually run it, it’s quickly approaching its stranding date.  

A stranding date is the point at which it’s no longer viable as a building for your investment. So you may have a brand new building, but you could be surprised at how quickly it loses value. By comparison, a much older building (eg, one that doesn’t have air conditioning) is further away from its stranding date because it has much lower energy usage.  It’s probably still going to be difficult to rent because of its age, but stranded assets are a big issue in this market now, because the cost of refurb is often greater than the value of the building.

This makes it very difficult to predict what to do: do you make a big investment in your building, only to find that the market has once again shifted direction? There’s a lot of flux and a lot of indecision around what the right thing to do is, and if you don’t know, you may be tempted to simply sit on your hands rather than make a wrong decision.

Sadly, I don’t have all the answers to these issues, but it’s important to be aware of them, especially if you’re planning to move into the commercial market. If you’re thinking about really making a career in the property industry, it can be a daunting experience, so why not invest in my FOUNDATIONS course? This course will take you through the fundamentals in simple, jargon-free language, explaining how the market functions, what you need to watch out for, and giving you the steps to help you avoid costly mistakes!