Originally published May 2023.

Do not write off the office

You may be forgiven for thinking that some people have forgotten how to wear trousers. Headline after headline for the past three years declaring that working life is now just one long Teams call, dressed only from the waist up, in box rooms, on kitchen tables or wherever else we can find to perch our laptops – but certainly not in the office. This is of course nonsense, but no one can deny that work is changing, with profound implications for global office markets.

Almost empty throughout the pandemic, many offices came back to life in 2022. While considerably less busy than they were, occupancy rates trended higher throughout the year as we all came back to the office for at least part of the week. In time, will things return to the way they were? This looks unlikely, but it’s important that we don’t view global offices through a single lens. There are today massive differences between assets, cities and regions. Some parts of the market elicit extreme caution, while others present an abundance of opportunities.

Office take-up gained momentum in Europe and APAC

Despite ongoing concerns over hybrid, demand for office space was surprisingly robust in 2022. Take-up rose across Europe and APAC, pushing net absorption firmly into positive territory. This was not the case in the US, with net absorption expected to have been negative for the third year in a row. Despite a recovery in leasing activity in the US, record lease expiries and a reduction in renewals resulted in occupiers shrinking their overall footprint, often in exchange for higher-quality space, according to JLL.

This shift towards higher-quality space was a common feature across many global office markets. Changing occupier needs, regulatory requirements, talent retention and net zero goals are leading a shift to quality. Last year – according to Costar – over 80% of all large (more than 25,000 square feet) leasing deals in New York were made in grade A buildings. This becomes 90% in the City of London, according to Savills.

We can’t just extrapolate the positives from last year into 2023. As a pro-cyclical sector, the office market is exposed to the expected slowdown in global economic growth, and beyond 2023 we do expect the shift to hybrid working to reduce total space requirements in many markets, as occupiers take a smaller amount of better-quality space.

Vacancy Rate by Location and Building Quality (Q3 2022)

Huge differences between regions

By far the biggest difference between markets is supply. From the lows of Seoul and the Paris CBD to the highs of Houston and Dallas, vacancy rates, across the major global markets that we cover, range from a mere 3% up to an enormous 27%. Putting aside ongoing structural changes, this alone is enough to explain our diverging outlook across global markets.

Since the start of the pandemic, no region has been immune to rising vacancy, but the US does stand out. Having been a high vacancy market for the past two decades, the average vacancy has jumped seven percentage points since 2019, sitting near 20% at the end of last year.

Given differences in definition, we need to be careful when comparing estimates of good quality “grade A” vacancy across markets. Nonetheless, the data also shows that following recent years, there is no shortage of this type of stock in the US. This is not the case in Europe and APAC. Not only has a lack of development kept down total vacancy in Europe and APAC, but it has also led to a notable shortfall in the availability of the highest quality stock.

We foresee no respite from these shortages in Europe. With question marks over hybrid working, possible recession, higher construction and financing costs, and recent falls in value, development pipelines are increasingly thin.

Not only this, but we also expect to see stock being withdrawn from the market. Whether the result of changing occupier requirements or regulatory requirements – such as minimum EPC ratings – there is a high possibility that poorly located, older, commodity office stock will no longer be lettable.

Our latest European outlook shows net completions turning negative before the end of the decade, and given the vacancy picture, we anticipate this could allow for a swift resumption of prime rental growth from 2024, with best in-class space, in cities such as London, Paris, Berlin and Stockholm recording rental growth well above inflation.

Differences, similarities, risks and opportunities

The office remains an integral part of business operations, but there is no denying that the way we work is changing, and with it the role of the office. Understanding this will be an important element when judging how to approach investment in the sector. However, this is not enough. There are huge differences between cities, from hybrid working practices to more traditional supply and demand dynamics.

As we look to the year ahead, the immediate outlook for offices is challenging. Tending to move in line with the economic cycle, the risk of recession and job losses suggests rental growth could be in short supply. Even beyond this year, the sector will be tested, and more than ever a full and detailed understanding of local market conditions and asset-level dynamics will be a necessity for any investment.

It may be some time before some investors are confident enough to deploy capital into today’s high vacancy US markets, but in many parts of Europe and APAC, the sector already looks well positioned. Changing occupier preferences are meeting a lack of good quality space and a diminishing pipeline, and should this continue, we strongly believe that best-in-class buildings in cities from London to Paris, Seoul to Sydney, will be well positioned for performance, creating opportunities for value add investors to refurbish well-located but aged buildings into the next generation of offices.