Julie Whelan:
We just spoke about how fundamentals are so important for a capital markets rebound, but office is the asset that has the most challenged fundamentals in today's environment. Reduced demand, rising vacancy and rents that are declining are all bellwethers of this market right now. For this discussion, I'm joined by Ada Choi, Asia-Pacific Office Research, and Jessica Morin in U.S. Office research. Welcome, Ada and Jessica.
Ada Choi:
Hello Julie.
Jessica Morin:
Good to see you, Julie.
Julie Whelan:
Great to see you both. So as you both know so well, the way we work has permanently changed. As a result, many occupiers are solving for new portfolio strategies and those strategies are often resulting in contraction. That reality is at the core of what is challenging office market fundamentals today. Now we just released our suite of occupier survey studies around the globe. I want to hear what you learned from that survey about how occupiers and employees have changed their office usage patterns. Ada, let's start with you from an Asia-Pacific perspective.
Ada Choi:
Sure, I would like to deliver some good news. I think Asia Pacific is leading the way in terms of return to the office. The average office utilization rate in the region was about 65% as at the end of Q1 2023 led by the greater China and North Asia markets, which have already been largely back to the pre-COVID levels. I think cultural factors, smaller home size and extensive public transportation system enables people to prefer to work at the office. However, we notice that even Asian companies have realized the importance of flexibility, and therefore they lowered expectation for their staff to work fully in the office. It only means that their staff can work from home if they need to, not meaning that they can work outside the office regularly.
Jessica Morin:
And in the U.S. and Europe office utilization's lower than what it is in Asia. In our spring 2023 occupier sentiment survey, more than 75% of respondents in Europe and the U.S. reported average utilization that's below 60%. And so while those averages look similar in the U.S. and in Europe, there are very key differences. So in the U.S. there's a greater variability in how organizations are utilizing the office, with many leaning into the office, but still some leaning into remote. Whereas in Europe, most organizations are really bought into this balanced hybrid approach with few leaning one direction or the other. So regardless of their approach to hybrid work, occupiers in both regions do expect office usage to increase through the remainder of this year and into 2024.
Julie Whelan:
Well, I find those regional differences interesting and we could have a whole conversation about what's behind them, but for now it's good news that usage is anticipated across most of the world to grow as we move into 2024. Now globally net absorption has fallen negative in 2023 and vacancy is on the rise, as I mentioned before. One thing I want to pick apart for our listeners is how much office fundamentals are struggling from the secular impacts of hybrid work that we just talked about versus that layered effect of the economic cycle that Richard spoke about. So Jessica, I know you've done some work on this lately. Let's start with you.
Jessica Morin:
Sure. So in the U.S. demand measured by tenants in the market has remained pretty stable so far this year, but office leasing activity has not yet stabilized. So what that tells me is that tenants are really deferring these leasing decisions until there's a greater degree of economic clarity. And so this mix of the economic uncertainty plus the hybrid work makes it difficult to discern which is the primary cause of reduced demand. But because we saw leasing activity exceed pre-pandemic levels for several months in 2021 before that economic uncertainty set in late last year, it’s likely that the cyclical events here are the bigger factors. So once we have economic stabilization, we can really expect to see a rebound in TIM and leasing activity. And then on top of that, construction completions also peaked in 2021 and they're likely to stay low for the foreseeable future. So that's also going to support market fundamentals once we see demand pick up in late 2024. And then talking to my colleagues in Europe, it's a similar story. Both factors are impacting the market, but economic challenges especially are impacting weak leasing activity in Europe so far this year. And so volume is down there by about 20% compared to where it was in the first half of 2022. And it's going to be the second half before we see any material signs of improvement there.
Ada Choi:
Well I think in Asia-Pacific I would say that the office performance is largely affected by the economic cycle and the supply peak that pushes vacancy to a 20-year high. Recovery in mainland China is weaker than expected while supply is really high resulting in further decline in rents.
Julie Whelan:
Okay, so it seems that this economic weakness is really a big part of the story right now and that once that passes or at least we get more clarity around it, that we can expect a rebound. Now you also both bring up a few good points that I would like to highlight. Jessica, I find that one stat is sometimes forgotten and that's in 2021 leasing activity for a few months exceeded pre-pandemic levels. So clearly we were seeing a rebound and we can expect that that is going to happen again once we have more certainty. And Ada, you specifically mentioned the supply peak. That is the story in many parts of the world where we continue to deliver a lot of supply to markets, but that's likely to slow going forward and there isn't a whole lot coming behind it. So this should automatically help fundamentals.
Julie Whelan:
Also, I would like to end with a bright spot for office: Rents have been buoyed by the prime office market, and that prime office market has been very resilient throughout the pandemic and into this year. Now flight to quality has always been a trend during recessionary periods, but the reason why was usually because occupiers were able to take better space for a lower cost. But this time the story is a little bit different because price sensitivity doesn't seem to be the driver behind success of the market. So what are your views on that? Ada, let's start with you.
Ada Choi:
Julie, I think nowadays people are comparing the workplace environment with their home as they can work from home. So for companies and occupiers, they realize that they need to provide a good working environment so as to boost office utilization. This drives the flight-to-quality relocation with strong preference to offices with good transportation and amenities. Jessica, how about your markets?
Jessica Morin:
Yeah, in Europe and the U.S., the trend is very similar to what you described in Asia-Pacific. The flight to quality actually may even be more pronounced because as we discussed earlier, employees in these regions have more choice. And so employers are using the office to draw them back through better location, aesthetics and amenities. And so in Europe, access to transportation and sustainability features are really becoming much more prominent factors when tenants are selecting locations and their buildings. And so as evidenced, supply conditions in the core and CBD markets are much tighter and occupier choice is much more constrained. For example, in Paris, their overall vacancy rate is around 7.5%, but in the CBD, it's just over 2%. And so we are seeing prime rents across Europe that are generally at least stable and in some cases it's rising. In the U.S. we're also witnessing this flight to quality and it's especially apparent in younger buildings. So consistently we've seen positive net absorption in buildings that were built since 2010 throughout the pandemic. And the vacancy rate in these buildings are about 400 basis points below the overall average. In Manhattan, the availability rate for mid- and lower-quality buildings is near 21%. But for better buildings in the Midtown core where there's this easy access to transportation and renovated and well-amenitized buildings, that rate is closer to 13%.
Julie Whelan:
Wow. So you have just both described that bifurcation in the market that we're seeing. So thank you, Ada and Jessica.
