Corporate office is not dead, say landlords

The corporate office is not dead but the pandemic has accelerated trends already under way and stalled long-term decisions by tenants as landlords scramble to stitch up leases.

Despite being confronted by half-empty office towers, severe work-from-home restrictions and harsh social distancing rules, landlords are confident underlying demand for workplaces will rebound and their company financial results by and large back them up.

Dexus executive Kevin George demonstrates new touchless biometric building access. Credit: Nick Moir

While COVID-19 has put a blow torch to the retail sector, diversified developer Mirvac this week reported rent collection from its offices was 93 per cent fulfilled in the June quarter, compared to 58 per cent among its shopping assets.

Large corporate tenants are concentrating on health and safety, touchless technologies and building floor plates that are adaptable for how they will use the office space into the future.

"There is a clear differentiation between buildings which are fit for purpose and those which are going to be rapidly obsolete," the company's chief executive and managing director Susan Lloyd-Hurwitz said.

"The pandemic has stepped on the accelerator of all those trends and we will see increasing bifurcation between buildings that our customers want to occupy and ones which don’t suit anymore," she said.

Challenges abound in the short term.

The $8.2 billion ASX-listed company's head of office and industrial, Campbell Hanan, said over the three months to June, the group experienced a "freezing of leasing activity in office markets."

"I certainly don’t think we’re alone in that," he said.

Incentives – the rent concessions offered to attract tenants – are starting to tick up significantly, hitting 25 per cent in Sydney and even higher in Melbourne, around 30 per cent.

The company also expects to see some deterioration in effective rent growth. "A lot of tenants are unwilling to move in this environment and turnover is particularly low."

Morgan Stanley analysts Lauren Berry and Simon Chan point out that while retail leasing spreads are now negative, Mirvac has "just 25 per cent of leases expiring over 2021 to 2023, far less than peers."

Its status as the country's largest office owner and manager makes the $9.4 billion heavyweight Dexus a litmus test of market sentiment.

Demand across major CBD office markets is likely to be "patchy" in the short term, the group's executive general manager of office, Kevin George, admits. Office leasing enquiry levels are falling and inspection rates are slowing.

Office portfolio like-for-like income growth fell to 2.4 per cent, down from 3.4 per cent the year before, a result driven by rent relief for pandemic-stricken tenants and provisions for expected credit losses.

"The office is not dead, [but] we are seeing a flight to quality assets," Mr George said. "We’re piloting a number of healthy building technologies to ensure our buildings continue to deliver quality environments into the future."

Defensive assets are proving resilient in the face of the turmoil created by the pandemic, a trend city-fringe office specialist Growthpoint Properties Australia is expecting to exploit.

It controls a string of east coast office towers ideally suited to the hub and spoke model, seen as a compromise between working from home and moving back to the CBD head office.

Aware of the need for workers to be nearer to their offices, many businesses are considering downsizing headquarters and providing more space in smaller suburban buildings, Growthpoint's chief Timothy Collyer said.

Rents are much lower and the buildings are usually closer to where people live. But he was cautions against making quick assumptions about the market.

"It does take a long time for those broader trends to play out."

Growthpoint is concentrating on re-leasing space to existing tenants. "We re-leased 19 per cent of our income, the majority to existing tenants," he said.

Lendlease chief executive Steve McCann understands there are upsides to working from home, but says there are downsides too – the lack of human interaction and impacts on mental health and wellbeing.

"That bump factor that enables better innovation within a workplace is being increasingly recognised."

"We see an ongoing demand for office," Mr McCann said. But there will also be some "adjustments".