Julie Whelan:
Welcome now, Ada Choi our Head of Office Research for Asia Pacific and Jessica Morin, our Head of Office Research for the United States to talk about the office outlook. .Welcome Ada and Jessica. Good morning. So I'm gonna pose this first question to both of you. The global office market has been in the hot seat, as we all know so well for the two past two plus years, and its very existence has been called into question. So from your perspective, what is the state of the market today in major markets around the world?
Jessica Morin:
So in the U.S., The worst really seems to be behind us. Over the past three quarters, we have seen that move-ins have actually exceeded move out. Vacancies are starting to stabilize, although they reached a nearly 30-year high and asking rents are starting to moderately rise. And same thing across major markets. We've seen vacancies are stabilizing or decreasing except with a few exceptions like in Berlin and Barcelona. Now on the return to office side, in both regions, the U.S. And Europe, it has been slow, but we do expect occupancy levels to really start to pick up in the fall once employers really make it more clear what their expectations are for their employees. But with that said, the majority of employers, both in the U.S. And in Europe do support hybrid work. So we do expect employees to be in the office less and that will have an overall net negative impact on demand.
Jessica Morin:
But by our estimates, that's about 9%-15%. We do see that the reduction in demand is going to be offset by the change in how we are actually using space and design will accommodate that. So for example, we're gonna have less individual desk space and we're gonna have a lot more shared open space for collaboration. So in the long run we expect that job growth will continue. We'll see a moderation in new supply and that in combination will balance out any kind of reduction in demand in the near term or in the longer run.
Ada Choi:
I think Jessica, if you compare Asia Pacific, we are coming out from this crisis earlier. I look at the net absorption in 2021. In fact, it has increased 40% last year in APAC. It's a very strong rebound. However, for this year we are expecting this demand momentum to be normalizing. Of course, APAC is a huge is quite a big region. So the supply and vacancy for the rentals vary significantly. If we look at mainland China, particularly Shanghai, it was largely affected by the restrictions and city lockdowns in Q2. So the numbers did not look well, but for the other markets that have limited supply, rents are escalating. This includes Singapore, Seoul and Sydney, and we noticed that occupiers have to plan ahead to secure the space. Meanwhile some of the occupiers can enjoy more optionality and rental discounts. The rental cycle will last longer in mainland China, Hong Kong, Tokyo, and some of the Southeast Asian markets.
Julie Whelan:
Great. Thank you for those insights. It's always important to look market to market because real estate is still a very local discussion. So here in the U.S., We have seen enhanced trends and we hear a lot of anecdotes around the flight to quality. So Jessica, I'm interested to hear if you have data that supports those anecdotes and then Ada would be really interested to understand if you're seeing the same trends in Asia Pacific.
Jessica Morin:
Yeah, so we do have the data to support flight to quality. So in the second quarter in the U.S., we looked at 2,700 lease transactions across 12 of the largest U.S. Office markets from 2019 to the first half of this year. And we classified the building or the lease that took place as either top tier, which is that A/A+ space, or lower tier. And so what we saw is that base rents across all quality tiers increased this year. However, for lower-tier space, we saw that concessions in the forms of tenant improvement, allowances and free rent increased quite a bit in that lower-tier space. And so that had an net overall effect that brought effective rent down by 3.4% last year. And by 1.1% this year. Alternatively on the top-tier space, landlords have actually been able to roll back concessions because of strong demand for very high quality space.
Jessica Morin:
So we actually saw effective rents increase by 3.8% last year and by 6.7% so far this year. So the flight to quality is very real. We're seeing it in our data and this growing preference for sustainable features and buildings as well has really changed what we consider obsolete office. And it's gonna cast a wider net over the type of office space that we just don't expect to lease in this kind of climate. So that has really driven the conversations around office conversions and demolition to make way for multifamily, industrial and life sciences. And we're really starting to hear those conversations ramp up and it's not just conversations, it's planned projects that are underway or have been completed in the last couple of years as well. So we're seeing that really concentrated on the East Coast in Boston and suburban Maryland we've seen underway and planned projects for office-to-life sciences. In New Jersey there's a number of multifamily and industrial coming up from obsolete office. And then on the West Coast, we are seeing some examples in San Francisco peninsula in Orange County and in Phoenix of office-to-multifamily.
Julie Whelan:
Fascinating.
Ada Choi:
I think Julie and Jessica, in terms of this trend about flight to quality, Asia Pacific is not that different. And also in this region in many cases when it comes to relocation, flight to quality is associated with the workplace transformation initiatives. So the occupiers can use the new space for more flexible hybrid working style as well. I think another reason for this flight to quality is the ESG desire. So some of the relocation is to the greener buildings and we notice that many of them are new buildings as well. Well, I think there is a lot of discussion, whether those relocations involve downsizing and we notice this is true, but most of these moves are basically cost- or space-neutral as a trend we are seeing in Tokyo, in Taipei and several Australian markets. However, I think going forward there may be some resistance to this relocation because of the sharp escalation of federal cost. So this could potentially lower occupier intention to relocate as it is difficult to guess the budget. We know that some of the landlords are increasing incentives on tenant improvement or the fit-out period, or even provide the turnkey solutions. So it will be easier for them to attract the tenants.
Julie Whelan:
Very interesting. So it's clear that tenants want better space, they're willing to pay for it. And the rest of the market is really gonna get converted into highest and best use, which makes sense. There's a reshuffle going on. So as if the pandemic weren't enough to challenge office, we have what Richard talked about, which is a global economic slowdown and looming recession. So how does that outlook change your outlook for office in the near term?
Jessica Morin:
So a recession will begin demand for office space and it's going to further delay the U.S. Office recovery companies are going to look for where they can cut expenses. So I'd expect continued right-sizing and possibly an increase in short-term renewals. With that said, we have started seeing this play out. There's been a few tech companies that have been in the headlines for hiring freezes and layoffs. And these same companies have also pressed pause on planned office expansions and even their current underway build-out in cities like New York, San Francisco and Washington D.C. But aside from those few examples of companies, I do think we'll still continue to see leasing activity over the next several quarters, but occupiers are just going to move even more cautiously.
Ada Choi:
Well, I think for Asia Pacific, Richard has already mentioned there are two major effects. First of all, the Western MSCs are likely to be more cautious about the business investments or expansions in this region. And for Asian companies who rely on exports to the west, they will also be affected. However, we also notice that there is pent-up demand for several markets when who are relatively late when it comes to coming back to the office. India, for example, we have seen a very strong rebound in terms of the demand. Philippines is another example. I think Richard has also mentioned that we are optimistic about a recovery in China. So it's quite a counter cyclical kind of movement China, Hong Kong. We are going to see the recovery in 2023, and that's why we are expecting the demand to improve. In fact, in 2023 in that region, and it is expected that the Chinese government is going to prioritize the supports of the economic growth and provide some stimulus, for example, cutting the tax be more nice to the tech companies. So this will also help us as an office market to see the improvement in the demand for the later half or next year.
Julie Whelan:
Great, thank you, Ada and Jessica. So it seems the pandemic absolutely accelerated change for the office market. And it seems that those assets that get the right mix of location and design and amenities are really well positioned towards the future of office. Even if that future might take a bit longer to arrive in some places given the economic climate. So I thank you for both of your comments.
