Is Office-centricity Over?

Morgan Stanley expects office rent in Asia to decline 10-15% over the next three years, but with big corporations embracing working from home set-ups, rental reductions may increase.

In Tokyo’s Shibuya Ward, home to many IT firms who can quickly implement teleworking, cancellation of lease contracts by tenants in large office buildings have ramped up since June, according to the August issue of the Nikkei Real Estate Market report. The vacancy rate in Shibuya Ward climbed 0.83 percentage points to 3.38% as at the end of June, the highest in the five central wards of Tokyo.  In Singapore, a similar trend is emerging as a global skincare brand, among other companies, is also cutting the space it requires as it renegotiates its lease.

In May, Jack Dorsey, CEO of Twitter and Square, told his employee that they could continue to work from home (WFH) forever. Shopify’s founder Tobi Lutke tweeted in the same month that the company will keep its offices closed until 2021 so that it can “rework them for this new reality. And after that, most will permanently work remotely.” He declared: “office-centricity is over.” Facebook CEO Mark Zuckerberg also said that as much as 50% of their staff could be working entirely remotely in the next 5 to 10 years. 

80% worked from home in Asia

According to a Morgan Stanley survey, which was conducted between April and July, around 80% of the working population in Asia transitioned from office-based workers to remote working conditions at the height of the coronavirus pandemic. The survey showed that about 75 to 90% of employees currently working from home would like to keep the remote set-up even after the pandemic fizzles out.

With office rental making up 15 to 20% of businesses’ fixed operating costs, WFH is a cost-saving opportunity, said Morgan Stanley. It expects tenants across Asia to surrender 3 to 9% of their existing office space permanently. As a result, rentals will decline by about 10 to 15% over the next three years. 

 “We expect big tenants (financial institutions, IT) with well-established BCP [Business Continuity Plan]/WFH infrastructure to return 10% of their existing office space to landlords over the next three years. This will be achieved by asking certain functions to WFH permanently (HR, some parts of IT, back office), offshoring to cheaper locations (India, Vietnam, and desk sharing,” Morgan Stanley said in the report. 

With the success of WFH set-ups, landlords are potentially looking at continued decreases in occupancy rates. What may be a boon for employees and businesses is becoming a challenge for landlords. 

Tokyo’s outlook

In Japan, for example, SMBC Nikko Securities’ Senior Analyst Junichi Tazawa estimated that the overall negative impact of Covid-19 on GDP will be 7.5 trillion yen (US$68 billion). Vacancy rates in the five central wards of Tokyo could rise by 2.3 percentage points to about 4%, he said in a survey about the next 18 months real estate outlook, published in the July edition of the Nikkei Real Estate Market Report.

Rising vacancies are bad for landlords, but their bigger concern, according to Morgan Stanley, is that a large proportion of existing employees continue to WFH even after the pandemic is over. As such, the medium to long-term view for office space rental also remains weak. Companies are also expected to sign shorter leases as the future remains unclear. The uncertainty in working conditions lies with the unpredictable future of the global pandemic, and property stocks are factoring in the uncertainty with many trading at discounts to NAV.

Nomura Securities Managing Director Daisuke Fukushima said, “in the medium to long term, there is a risk that office demand will decline due to work from home taking root to a certain extent, and concerns over the future of rents are increasing.” 

At present, the bottoming out of the office market rental rate decline is estimated to be at the end of 2021,” Daiwa Real Estate Appraisal’s Chief Researcher Kazumasa Takeuchi forecasted.

Across the region, office spaces in developed economies like Australia and Japan are not expected to perform well compared to other spaces in Hong Kong in India, Morgan Stanley’s research report said.  

“Tokyo is the only city where rental increased in the first half of 2020, thus, we expect more rental downside from there… Sydney and Tokyo have the highest supply addition over the next three years, putting cyclical pressure on rents,” Morgan Stanley said. 

Downside for Suntec REIT

Hong Kong showed the worst decline (-13%) in rents in 1H20, implying that a lot of bad news is in the price, it said. It added that “Hong Kong and Indian stocks are trading at 55% discounts to NAV – and more importantly, 30% deeper than the long-term average.”

For Singapore real estate investment trusts (REITs), Morgan Stanley said the valuations of the three largest trusts – CapitaLand Commercial Trust (CCT), Suntec REIT (SUN), and Keppel REIT (KREIT) – are pricing in a 10 to 20% drop in office rents. 

“At these levels – particularly for our preferred office REIT, KREIT – we think that market concerns over structural headwinds due to the WFH trend seem overdone,” the research report said. 

For Japan, real estate stocks, Morgan Stanley “strongly favours” a cautious stance as discussions suggest that structural deterioration in office market conditions owing to the rising popularity of WFH is still not sufficiently discounted, and further fall in share prices is still possible.

Overall, Morgan Stanley said they see more downside to Singapore’s Suntec REIT, Australia’s GPT Group and Japan’s Mitsui Fudosan. On the other hand, Hong Kong’s Sun Hung Kai Properties (SHKP), Hongkong Land, and India’s DLF Limited are pricing in worst-case scenarios with regard to WFH conditions. 


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