BNP Paribas Real Estate’s Head of Research shares her insights on the future of office space in light of COVID-19
In this episode, IQ-EQ’s Tom Miller sits down with Stephanie McMahon, Head of Research for BNP Paribas Real Estate, to discuss the impact of COVID-19 on the short- and medium-term future of office space.
Throughout the discussion, Stephanie provides insight into the effect of COVID-19 on existing trends such as co-working and hot desking, the increased focus on redevelopment and space modification, new pandemic-related considerations around office location and common spaces, the rise of smart buildings, the renewed importance of occupier due diligence in relation to business resilience, and what all of this means for offices as an investment asset.
Stephanie has 19 years’ experience in real estate research, strategy and insights across all sub-sectors including commercial, residential and rural. She and her team at BNP Paribas Real Estate undertake strategic insight and market analysis for all UK real estate markets, with emphasis on structural rather than cyclical market shifts. Previously, Stephanie set up and led the research team at Strutt & Parker and before that was the strategic research lead for the Jones Lang LaSalle (JLL) team in the UK. Stephanie sits on the Urban Land Institute (ULI) UK Residential Council, the Investment Property Forum (IPF) Research Committee and the British Property Federation (BPF) Compact Living Committee.
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Hello, everyone. I'm delighted to welcome you to the IQ-EQ Real Estate Focus, our podcast series where we hear from experts on current hot topics in the real estate industry. I'm Tom Miller, your host for today, and I'm pleased to welcome Steph McMahon, Head of Research at BNP Paribas Real Estate. We're here to discuss the future of the office space. For the record, this was recorded on the 15th of June 2020, and I know Steph will be using some data, so please use that as a point of reference. Steph, welcome! Firstly, can you talk to us a little bit about how you see the future of the office space? I would like to keep this to the medium and short term. So for example, hot desking was a big thing; now it may be a thing of the past. We've seen a rise in co-working. To me, it seems intangible as we speak today. If you can start with setting the scene...
Yeah sure, hi Tom and thank you very much for inviting me to speak on your series, it’s great to be part of this. So you may wonder why you invited me, because my first sentence is probably going to be that no one really knows. I mean, everything we see and read at the moment, in my view, is quite a lot of chat about what the future of offices is going to look like. I get that because we need opinion; we need to have discussion. In my view, it's massively dependent on, as you'd expect, a vaccine, effective treatment etc. If that happens quite quickly, then I actually don't think a huge amount will change at all. But you have pulled out a couple of scenarios, so let's think about those in a little bit more detail. On the flex space, co-working space, do I think that that has got a future? Very much so. I mean, occupiers/businesses require short term space. They require different locations and the big driver to that co-working space has been enabling much more flexibility on an occupier’s decision-making. Real estate is really a relatively small part of their occupancy costs. Their massive costs, over 70%, are their people. So, being able to flex the real estate to suit the needs of their people is more important than having the longer term commitment on the real estate. So I don't think that is going to change because I actually think that occupiers, businesses are going to be less wanting to commit to major change until the situation is clearer. We're going to have to have differences in the way this is approached, but perhaps we can kind of pick up on that in a bit more detail as we go through our discussion. On the second one, you talked about hot desking. Again, yes, I do think it's going to remain. For me, this is very much about the cleaning regime and perhaps air quality. The interesting thing about high density open plan, which has been adopted by so many companies (my company included) is that it's almost the lowest common denominator in office space. It doesn't really cater to individual needs, but it is the most efficient way to use the square footage that you have. So being able to kind of combine that with home-working makes it a very efficient way of using office space. So, getting the right cleaning regimes etc. will be fundamental because I think longer term, it’s about how to make users of office spaces (or indeed any real estate spaces) feel safe and healthy, whilst balancing that with productivity whilst they're there.
A question touching a little bit on the high density points you mentioned. Given we have potentially some changes on how a space looks… Do you anticipate that asset owners will need to make a large CapEx expense in the near future, for example, for redesigning?
It's a really good question, and one that our property management teams and our building consultancy teams are spending a lot of time working with clients on at the moment. And so, I can kind of paint you a picture of a couple of clients currently. I think they're quite indicative of the approach to how to modify current office space. So one is a high density occupier looking at their new space. They're definitely in two minds as to whether this means less space for them plus more home working or the same level of space plus home working. You probably have seen these two scenarios being bandied around a lot. So whether you need the same, or even some people are saying more space, to have social distancing, or whether you need less and you increase your homeworking, that is very much a live discussion at the moment. I don't think that there is an answer to that, because it goes back to the previous point of, it depends very much on how treatable this pandemic becomes and how quickly that happens. Now interestingly, the second occupier, they operate in a very different sector and they occupy low density space within single-use offices. They really, therefore, don't have to change very much at all. So what from my perspective becomes interesting is, what are the commonalities that we can still see between these two quite extremes? So one of them is change of lift use. How do we manage lifts and stairwells to enable access in and out of the building? How do we manage the common spaces to allow access in and out of the building? Those are fundamentally important to me, central stairways instead of using lifts all the time, that's a trend that I think would be interesting to watch. Using push button doors so you don’t actually have to touch any handles at all is a pretty simple and low cost approach to actually getting around something that is a significant cleaning issue with people moving around the building constantly. Things like automated lighting, again, just anything that can reduce the amount of time or the amount that people have to touch communal surfaces are pretty low cost and can be implemented pretty quickly. And I think it's those sort of things that occupiers will be looking at in the short term. Longer term, I think more investment in digitising workflows and perhaps one of the things that I think will actually be a real long-lasting legacy from this is that what gets automated now will not go back. You know, this is the big tech acceleration. My personal view is that doesn't mean to say that we don't need communal or workspaces together, but if something gets automated now it's not going to revert to how it was. So then if we think that social distancing goes away at some point, what's going to stay, what's the longer term impact? So thinking again back to those commonalities, out of all the kind of hyperbole and chat around it at the moment, what do we think is going to remain? Well, two things for me, one is smart buildings. I think for new buildings there will be greater and greater demand for smart buildings and perhaps more plug and play activity in existing or refurbishment. What sort of things would those buildings want to be measuring? Well, air flow and air quality is an obvious one and it's something that I've been thinking about really for the last couple of years now quite a lot, since if you think about London, there's been quite a lot of media coverage of air quality in London. At the moment, we don't really have, a device, a wearable device or a phone that can tell us absolutely and easily and cheaply, importantly, what the air quality is like around us. I think the once that happens, and this could accelerate that, then how we use cities, how we use public transport and then to the micro of how we use buildings could have a really huge shift. And the other bit to me that's interesting is use of personal data. If we think about why people share personal data at the moment, often it's about social media activity. So engaging with your cohort, your tribe, your community. And for users, for the data makers if you like, we're happy to, with that arbitrage because it allows us to be able to access to our social activities. I think people historically will have been less comfortable with that for other reasons. But now if the arbitrage is about your personal health, then I think that again becomes worth it for many individuals. So if that shift takes place and even some of the government policies around track and trace etc., would drive that, then how buildings and urban landscapes and transport systems can take advantage of that by monitoring flow of people, making sure the buildings are increasing or decreasing air flow and air quality in different parts of the spaces, monitoring how lift use is being managed and tracked through the numbers of people going through buildings and even monitoring therefore whether this space is being used productively, for me, that's potentially a massive, massive game changer in office use.
Steph I think that was really fascinating. I think we could probably do a whole session on smart buildings and the data around that. I want to go back to the uptake of office space. We clearly saw a trend of change of usage. We saw law firms going into open space, we think flexi hours. We obviously saw a tidal surge of working from home, to say to some extent. What is your anticipation of the uptake of office space as a new norm? Do you think it would go back to where it was or decrease? Can you talk a little bit about that?
Yeah, sure. So, as you say, when we get back to the new norm, I mean the short term clearly the take up is going to be severely affected. And when we look at our quarter one stats, I mean, we're in the process of doing our quarter two stats but looking at quarter one, we were 70% down year on year in the UK, and we expect Europe to be close to 40% down by the end of the year on office take-up. So we have a very significant short term hit, which is going to be pretty painful for any of us involved with leasing activity. Longer term, it does come back to the point that I raised right at the beginning. I don't think we know yet what the new office format looks like, so that balance of home working versus being in the office. One thing I do believe is that we need office space. So, if we think about why would a company pay or a retailer or a third party logistics provider pay a certain rent to be in the building. Well they pay that because they think they're getting some level of productivity out of it, whether that's economic or otherwise. So if we put that on a kind of human level in offices, companies will pay the rents they do, because they believe that there is probably an economic productivity to that shared space. So, for me, that means that we will still require office space. Now exactly what the balance of home working versus other looks like, it's going to be really interesting to see as time goes on. My personal view, having done a lot of home working over my career and also being a kind of analyst and therefore relatively introverted and quite happy to sit on my own for most of the day; there's still a tipping point whereby when your colleagues are in the office, you need to be there. I work with a lot of people, just thinking about my personal situation. I work with a lot of people who are sales people, marketing people, operational functions etc., and they have quite different personality profiles to me. And once over half of them are back in the office, I need to be able to engage with them on a face-to-face basis, at least part of the time. So for me, that is the thesis behind why we will still have offices. Now for some, there probably is going to be the opportunity for them to reduce that. Again, it probably comes back to how quickly we're able to treat this particular health crisis or in fact, any other health crisis that we might come across in the future. So, I would say that there probably, in overall terms, I would say that there probably is a risk to take-up and that we might see that continuing to decline – or at least continuing to decline for those very, very long leases apart from one HQ space – and creating more flexibility through the portfolio, which will allow companies to really gauge up or down where the workforce is. I think that that need for flexibility has been there now for the past decade, and I don't think this is going to change that.
Maybe you can talk to us a little bit on your expectations of the years for the office space, the office assets. I read your report in April, the COVID report, which says you expect the year, you’re estimating around 20 basis points. Maybe you can share a little bit on that, perhaps one or two insights to help us understand how you came to that figure.
Yeah, sure. Our year forecast has remained at that point and the inputs are very much determined around future pipeline, delivery, vacancy and pressure on rents. And the one that we're looking quite a lot at moment is that future pipeline, so the delivery of new or refurbished space. It is very, very tight across most of the prime European markets. And that's the reason why we don't have yield softening more than 20 bits at the current time, because there just isn't that much kit coming through and companies will still want to have high quality spaces. As I said previously, your biggest cost is people. So being able to attract and retain talent will not go away, even if you are doing a level of home working or some other form of flexible working. I think we'll see bigger shifts in the secondary markets and those inputs will definitely be more challenged. One of the upsides from a real estate investment perspective, if you like, is that the risk premia is very unlikely to be pressurised by bond rates in the short to medium term. I think if I was looking to invest at the current time, I would probably be asking myself whether that risk premia still genuinely reflects the risk attached to the covenant of the occupier or occupiers of the building I’m buying. Because you know, the need to really understand the operations of those occupiers, I think is going to be fundamental in the future. In the past, it was like, is it a long lease? Yes, tick. Is it government? Yes, tick, therefore we pay X yield on it. For certain government assets or what were kind of seen as, you know, ‘bomb proof’, perhaps it will be the same, but for others I think that there will need to be a bit more due diligence into really what that income risk is going to be. And that's been really held up very clearly through the last few months as we come up to the next red quarter date. So, I guess if I was one of your listeners at the moment, what I would say is the spread on forecast at the moment is huge and that is always such a strong indicator of volatility and uncertainty. We contribute to the Investment Property Forum Forecast (the IPF), and they do consensus forecasts for both the UK and Europe and they're fascinating at the moment because there is very little consensus in their consensus forecast. I think that is a good place to look in addition to looking at research houses such as mine because it really does give a view as to where we are at.
And finally, do you think offices are attractive assets for investors?
It is about efficiency and productivity in whichever way you choose to measure that. I don't think there are that many businesses that can get away with having none of that, unless you do it with your whole workforce. I think it’s when you have this kind of hybrid of some workforce together and some not, that's quite challenging. I don't know if you've noticed this. I really notice this, that the level of communication between me and my colleagues, both within the team and across different functions at the moment is amazing. It's really, really high levels of communication. But once a good section of those people that find themselves back, being able to do that face-to-face from their desks or the coffee machine or whatever it is, we will naturally become less good at communicating with people we can't see. I think that's just the nature of it. So for me, if your productivity is driven by your people being able to communicate, then you're going to want to put them in an office space and you're going to want to put them in the right place and pay the necessary rent to do that. I think it does make location interesting. I mean, again, this is a short-term thing. If we look at London, for example, at the moment, it's so reliant on public transport, the workforce that is particularly vulnerable to this kind of health situation. So it might be that companies will look at their business impact analysis and location will become an expanded priority of that. Whereas previously we might say, well, everyone goes into a disaster recovery centre that hasn't proved a very useful outcome with this particular situation. So unpacking how the portfolio supports business impact I think is going to be really, really important.
Thank you very much Steph for your time today and for sharing your insight with us. Thank you everyone who joined in and listened in today. If you have any questions for myself or Steph please don't hesitate to get in touch with us. Thank you very much and have a good day.