Updated: May 12
In a recent blog post, I identified three potential impacts for landlords of Australian office buildings which I think will linger after the current Coronavirus crisis is over:
a loss of momentum for in-house leasing;
a pause on placemaking, with fewer experiences and less events; and,
a shift in focus from environmental sustainability to technological connectivity.
You can read that post here: https://www.cresuccess.co/post/covid-19-impacts-office-landlords
This blog post focuses on the impact on office tenants; keep an eye out for the third and final blog post in this series which will discuss the impact on commercial real estate (CRE) service providers.
Here are three predictions of the impact on tenants of office space in Australia in a post COVID-19 world.
1. A rise in occupancy costs for many – and outgoings are going up
The broad consensus seems to be that tenants will emerge from this crisis with a lower real estate cost base. The logic goes that a combination of a higher propensity to work from home, a smaller workforce and a fall in effective rentals mean that occupancy costs will go down. In and of itself, this is true.
However, many tenants are locked into long term leases. Unless tenants have the opportunity to take advantage of the current circumstances to negotiate lease restructures, or have an upcoming lease expiry, the temporary rental relief that some are now entitled to under current guidelines will disappear.
Once the market reverts to existing leases, the escalations that were previously in place will still apply and rent reviews with ratchet clauses will prevent rents from falling. Yes, market rents will be lower, but that won’t help tenants stuck on leases negotiated before March 2020.
Furthermore, for tenants looking to drop space, subleasing, which was previously commonplace, will become harder as demand falls and more direct vacancy becomes available in competition. Even if subleasing can be done, the achievable rents for that space will be lower, too.
For tenants who have the opportunity to renegotiate their leases, their cost-base could fall due to space reductions and lower effective rentals. However, it’s not clear to what extent tenants will be able to reduce their footprint.
Yes, some employees moving towards more flexible working arrangements that includes a greater propensity to work from home (or elsewhere) means that there will be less people in the office each day. However, social-distancing measures mean employees will be resistant to close quarters, potentially requiring some remodelling of current seating configurations. Existing meeting rooms will need to be remodelled, and regular cleaning put in place. This will all create cost and offset some or all of the space savings as a result of more people working from home, or due to smaller workforces.
In addition, landlords will not be absorbing all the additional costs that are associated with disinfecting high-touch areas in buildings. Common area cleaning charges, other operational upgrades like contactless security and elevators, and various other measures that tenants demand and social distancing practices require, will create more operating expenses. These additional costs will not be absorbed by landlords – particularly given the extent to which owners have been forced to absorb short-term financial impacts under the current regulations.
There may be a case for outgoings (known in other markets as common area management fees) to be temporarily lower right now due to land tax savings and reduced operating capacity, however the cost of operating buildings will inevitably go up, and these costs will be passed through to tenants via higher outgoings.
2. Working close to home – a hybrid approach
Prior to COVID-19, employees had two choices: working in the office and, if an option, working from home (typically one day a week). Over the past couple of months, most have had one choice: working from home.
After months at home, people are now questioning the extent to which commuters will be willing to be packed into public transport, or sit in traffic every day, once they are “allowed” to return to the office.
At the same time, many people will probably be sick of working from home, and the need for human connection will give rise to individuals wanting a new alternative.
Enter the work-close-to-home option within co-working spaces. This would provide people with the opportunity to work in a professional and built-to-purpose office setting, without having to stay at home. It would reduce travel time substantially, cutting congestion on our roads and taking the pressure off over-crowded public transport.
Large companies could reserve many seats in these suburban co-working premises every day given they have clusters of staff living close by that would each be using the spaces a few days a week. Utilising a co-working provider and providing it as an option for employees would be more efficient for larger and smaller companies than directly leasing smaller spaces to cater for suburban-based employees all over the metropolitan area.
Furthermore, larger companies could have branded “hubs” within the suburban co-working centres to facilitate interactions between their staff. The curated hubs would create collaboration opportunities that working from home can’t cater for, while also ensuring people maintain a sense of connection with their employer that is not possible when not in the office. The work-close-to-home model would improve the human experience element and put in place measures to stop employee engagement levels from falling.
In terms of where these spaces will be, even before COVID-19 there was talk about discount department stores like Big W and Target closing underperforming locations, and other large format discretionary retailers shedding space. These spaces will need to be filled, and they can’t all be gyms, restaurants and child-care centres! A new alternative use for these spaces is suburban co-working. In terms of accessibility, they’re well set up: the locations already have an abundance of car parking and the majority are also located at public transport nodes.
A couple of co-working operators I have spoken to recently have also referred to a hotel management-style agreement with landlords of suburban office buildings to fill this expected increase in demand. If this model has potential, it will underpin the viability of some new construction of suburban office buildings that are not currently on the development radar.
3. A more flexible and contingent workforce – accelerating the activity-based workplace trends
As noted above, there may be some reversal in the contraction of workspace ratios trend due to social distancing measures. Tenants will also need to introduce disinfecting protocols to ensure shared workspaces are kept clean. However, due to a more flexible and contingent workforce, activity-based working solutions will become more common.
Australia has a relatively low level of workplace flexibility (in terms of employment laws) compared with many other liberal democracies. Furthermore, Europe and North America have a far higher proportion of their workforce classified as contingent (i.e. temporary or contract based). This Coronavirus crisis will result in a closing of the gap between Australia and comparable nations i.e. there will be more contingent workers here in the future.
Of the scores of people who have already been made redundant in the past two months, many will start their own consultancies or begin work as independent contractors – partly due to necessity, because full time work is not available. These professionals may well find they prefer the increased flexibility that comes from being a consultant, and as we enter economic recovery, businesses will also be attracted to hiring consultants over permanent employees due to the lower fixed costs. The idea of paying for outcomes rather than input or work hours is also consistent with the current working from home experiment.
Further to this, the federal government is already talking about using COVID-19 as an opportunity to increase flexible workplace arrangements. WorkChoices was first introduced back in March 2005 – given all the water under the bridge since then, those types of employment law measures could yet make a comeback. Regardless of whether it’s the Coalition or Labor who introduces the next round of workplace reforms, I seriously doubt the result will be greater employment security for workers.
The real estate impact of all this is that a more flexible and contingent workforce means it makes even less sense for tenants to provide their works with an assigned desk in the office. This will result in activity-based workplace design principles becoming even more common than they already are.
Ultimately, the way we will work after the current Coronavirus restrictions are eased is unknown. What most of us can agree on now is that there will be a lasting impact and things won’t just go back to how they were before. I offer up these predictions to contribute to the ongoing discussion and to help landlords, tenants and their service providers prepare for the new normal.
If you have any ideas to contribute, or would like more information, please drop me an email: firstname.lastname@example.org
I will share what I think the impact will be to CRE firms in the final blog post in this series.