By V Sanjugtha
IT’S bad. The world’s economic wheels have almost come to a grinding halt. Practically overnight, every office in major economic pulses has closed its doors and business suits are being swapped for PJs and t-shirts as major decisions are made from the safety of home to prevent the spread of the Covid-19.
Some sound the death knell of globalisation as countries guard their borders vehemently, while others prophesied the contrary as the world embarks on a forced experimentation of the biggest work-from-home exercise ever.
Overnight, applications supporting meetings have skyrocketed in popularity and property consultants are wondering what this would mean for the future of office space. Worse yet, where does this leave a sector already struggling with oversupply and stagnating rental rates?
Colliers International, in its research on the impact of Covid-19 on the real estate lifecycle, notes that the office sector is likely to be the last to feel the impact as a large portion of office tenants are still able to conduct operations and will be able to cover their rent for the near future. The percentage of tenants that can function in this format is much higher than retail, hospitality and industrial.
In the longer term, however, businesses are likely to experience a drop in revenue, as operations will be affected by the global recessionary impact on the markets. Depending on the success of the forced large-scale remote working exercise, a likely blending of remote and in-person work could push corporate clients to reconsider the amount of office space they buy or lease.
Dampened business sentiments may lead to organisational downsizing, contributing to lower demand for space in the foreseeable future.
“It’s reasonable for us to anticipate that we are going to have an increase in vacancy and a slowdown in take-up of office space as offices scramble to manage overheads,” real estate agency, Rahim & Co International CEO Siva Shanker tells FocusM.
“That puts some downward pressure on pricing but it will play itself out,” he adds.
Knight Frank Malaysia executive director of capital markets James Buckley says there could be a possibility that “Covid-19 could permanently shift working patterns when normal times return”.
Citing evidence from the 2019 IWG Global workplace survey conducted prior to the pandemic, Buckley notes that there is a high degree of flexible working adaptation across the globe.
He also points out that 65% of businesses say flexible working helps them to reduce capital expenditure, operating expenditure and manage risk, while 85% of respondents confirm that productivity has increased in their businesses as a result of greater flexibility.
“This does not mean the death of the office, but we could see a shift in the working model where it becomes more a place for connection, socialisation, creativity and innovation. Office accommodation is a high fixed cost and business leaders may consider whether it is actually necessary for all teams to have a dedicated desk,” he points out.
Buckley adds that hot desking, remote working and some provision of co-working can help certain types of businesses to reduce this fixed cost and also provide flexibility to scale up or reduce business space as and when required.
Rethink the future of office space
According to CBRE WTW Research’s Real Estate Market Outlook 2020, the four notable completions of purpose-built office (PBO) — Menara Etiqa in Bangsar, Symphony Square in Petaling Jaya, Menara Prudential in Tun Razak Exchange (TRX) and KYM Tower in Mutiara Damansara — have pushed up cumulative supply to 111.9 million sq ft and vacancy rate to 19%.
Another 10.23 million sq ft or 17 PBOs are in the pipeline and could push the vacancy rate even higher to between 19.9% and 21.5% in the next three years. New notable office buildings entering the market are Exchange 106, Sapura HQ, HSBC HQ and Affin HQ, each with more than half a million sq ft of space.
The average office rental rate and yield were at RM6.95 per sq ft and 5.5-6.0% respectively as of 3Q 2019. While TRX welcomed its first tenant, Prudential Insurance, into Menara Prudential, the move left a large vacant space at the insurer’s previous location.
While other financial institutions located within the Kuala Lumpur Golden Triangle are expected to move into their own buildings in TRX, this will leave many potentially large prime office spaces vacant for a period of time. Given the impending global recession, landlords are unlikely to fill these spots too soon.
“With the financial system in chaos, demand for new office space may be slower and those thinking of moving or upscaling may not do so. We have to accept that prospects for growth are over so we aim for as flat a curve as possible,” Siva points out.
He elaborates that the key to ensuring the downward curve is as small as possible is by “managing panic” as many times perception drives the market more than reality.
He calls on business owners and leaders not to panic unduly but conduct business as close to normal as possible.
“It is what it is, so let’s start planning for 2021,” he says.
“Organisations cannot operate with employees working from home on a long-term basis. Eventually, the demand for office space will return,” he predicts, adding that it may take some six months to a year before the curve tips upwards.
A special report by CBRE Research, “Why the coronavirus outbreak could have a lasting impact on Asia Pacific Real Estate” finds that the pandemic will create further opportunities for office occupiers to test the feasibility of flexible working or agile working in many markets.
The research finds that companies are likely to be more willing to accelerate the adoption of flexible and home working policies in future.
This leads to questions on space utilisation in agile workplaces, which will be re-evaluated due to the need to maintain comfortable density as opposed to high density to limit the transmission of diseases.
“At the same time, the workforce will become more mobile along with the greater adoption of flexible working after the outbreak. Occupiers will need to balance space efficiency with employee health and safety considerations, which may lead to slower growth in space requirements,” the report states.
As such, CBRE WTW Johor branch director Tan Ka Leong advises developers or owners to rethink any development that incorporates office space. As technology becomes an enabler for remote meetings, agile working environments are likely to subjugate the traditional office, but not replace it. He notes that previous requirements for large office space or conference halls may no longer be viable.
“In the long term, the criteria or requirements for office space will reduce as demand for office space is largely driven by the need for large conference rooms. When the industry sees this is no longer a need, demand for space is likely to drop,” Tan predicts.
Rental returns and dipping yields
“The smart landlord will give in to requests for rent-free periods or rebates or some form of relief on rent obligations. This will of course impact bottom lines and for listed companies, the repercussions are probably more severe,” Siva opines.
He points out that contracts are binding. However, he believes landlords will exercise flexibility to avoid losing tenants who may otherwise opt to shutter, thus leaving more vacant space to fill.
The impending downward pressure on rental rates and yields, according to Siva, is not uncommon in a recessionary economy. However, he reminds that owners with holding power will benefit as the economy is bound to bounce back, and historically “it will be higher or same as the last high”.
Siva feels landlords and building owners should seek out property experts to analyse and evaluate their portfolio for restructuring.
“Seek out consultants. Let the experts negotiate with your tenants on your behalf and restructure your portfolio to be more efficient in these difficult times,” he advises.
The prevailing lacklustre office market in Johor may take a harder hit in the current economy as new office buildings continue entering the market. Average vacancy rates hover circa 35% with market players already offering competitive rental packages to seize the limited pool of office users.
It is believed some of the newer buildings with asking prices of around RM5 per sq ft are experiencing occupancy rates of about 30% only. The older buildings, which have been around for about 20 years, are let out for about RM2.50 to RM3 per sq ft, achieving 70-80% occupancy rates.
“The newer buildings are asking for almost double what tenants are paying in their existing office. Only when the price gap between the older buildings and the newer ones closes will the businesses find it attractive,” Tan observes.
“Grade A buildings have only come into the Johor market over the past two to three years. There are limited takers. Most businesses in JB are SMEs, operating on a budget. Unless the market is able to attract multinational companies, it will remain subdued, regardless of economic conditions.”
The grand plans for Iskandar Malaysia have not taken off as expected, and despite the depressed rental rates, MNCs from Singapore still do not see the viability of relocating operations across the Causeway due to the lack of quality human capital.
With the month-long movement control order (MCO) affecting business operations and dampening overall business sentiments, Tan does not discount business closures which will raise the vacancy rates even further. Rent discounts and sweeteners will inevitably be thrown in, but Tan points out that the market lacks investors who find Iskandar Malaysia viable for operations.
Knight Frank Malaysia executive director of corporate services Teh Young Khean points out that with business sentiment at its lowest level, many operations are expected to be severely impacted by the Covid-19 outbreak.
“The sense of uncertainty will lead to slower demand as businesses and occupiers will likely continue to postpone major expansion or relocation decisions,” he notes.
Siva concurs, adding that cancellation of leasing contracts is on the cards, as it would with any recessionary environment.
“Those who have not signed the contract are likely to ask for a deferment or may take up less space,” he notes.
Tan points out that with the uncertainty in the business environment, most companies will be reluctant to spend on capital expenditure, which will lead to cancellations or postponements of planned leases.
“In short, for the next year or so, the office market will not see much tenant movement,” he opines.
He adds that both local and multinational companies are likely to put off their real estate decisions, and this may result in lower levels of leasing activity. — April 10, 2020
