Is this the death of the CBD?

Podcast transcript

Velvet-Belle Templeman

Welcome to Boardroom.Media.  My name is Velvet-Belle Templeman, and I'm here talking to Sian Sinclair, National Head of Real Estate and Construction at Grant Thornton, and Ken Morrison, Chief Executive of the Property Council of Australia, the national representative body of the property industry.  Today, we're talking about the future of work and how this will impact commercial real estate.  With the future of work being redefined at the moment with more and more businesses embracing flexible working, what might this mean for our city skylines?  Thanks so much for joining us, Sian and Ken.

Ken Morrison

My pleasure.

Sian Sinclair

Thanks for having us Velvet-Belle.

Velvet-Belle Templeman

COVID-19 must have been a shock to the commercial property sector with offices and CBDs generally deserted within weeks, but we're now three, four months in and many are looking to the other side of the lockdown period.  How are commercial offices and workplaces faring at the moment?

Sian Sinclair

Well, Velvet-Belle, I mean, Australia's commercial property market, it's really the heart of city-ism.  So therefore, it's vital to our Australian economy to have these places productive and thriving.  So seeing these deserted at the moment, it's quite confronting, and for those of us that were sort of still frequenting the CBD during this period, it's certainly where you saw the real impact of the shutdowns.  You know, seeing your CBD as a bit of a ghost town and it's hard to find somewhere to buy some lunch.  It's just such a contrast.  But we've now moved through to that tentative time where employers are sort of trying to read the needs of their people, balance them with the needs of their business and work out what business as usual is actually going to look like.  And of course, the priority at the moment is really about making the workplace COVID safe, you know, between the various requirements around distancing and the hygiene practises that need to be incorporated into daily life that's a lot for the landlords and employers to kind of grapple with right now.

Velvet-Belle Templeman

Ken you're at the heart of the sector, how are commercial landlords being impacted?

Ken Morrison

Well, there's a lot going on.  We've seen over the last two to three months, of course, their tenants being impacted quite considerably.  So the National Cabinet announced a Commercial Leasing Code to deal with that issue.  But even before that was announced, landlords were reaching out to their tenants to provide whatever the appropriate relief was.  Sian has just talked about the fact that we've had our office buildings emptying out over that period and now the return to work focus.  And I think there's just a lot of uncertainty, and I think this is the same, right across the economy, but the uncertainty of, of what comes next with this thing and how to think about, you know, the social distance ring requirements.  We've had a lot of uncertainty for a period of time around what you can do with lifts.  We've got a lot of uncertainty around public transport, particularly in Sydney and Melbourne, which are very heavily depended on, public transport to get to work.

And we're seeing that come out in tenant surveys, quite considerably.  Concern from people about being on crowded public transport and then of course, we've got the uncertainty about whether this is a sort of a linear March out of lockdown.  As we're recording this, we've just had the announcement that Victoria has had to delay some of the re-openings because of concerns about a spike in virus cases.  So we do all live in fear of that second wave and what that might mean for our business planning. 

So there's a lot to do.  There's a lot of work to do.  It's been a lot of economic hardship.  There's been a direct legislative Code of Conduct, which has made obligations on landlords to provide tenant relief to tenants.  So there's certainly been a lot of balls in the air for landlords over this period.

Velvet-Belle Templeman

And Sian, with the increase of people working from home and we're hearing this has worked well for a lot of businesses.  Does this mean the demand for existing office space has dropped?

Sian Sinclair

Well Velvet, at the moment, like you've kind of got those who are just wanting life to return to normal.  They’re sort of chomping at the bit to get back to the office, but that's not as simple as simply just showing back up at work.  There's a process to go through to get that workspace ready for people to come back and it's not necessarily returning to normal because normal has changed.  So employers are having to balance these who are wanting to be back in the office with those employers who are feeling more cautious about the return to the office, and particularly around that concern of the public transport and how they're going to get there.  You know, in our own workforce of about 1200, we'd done surveys and over 80 per cent are saying they want to incorporate a more regular work from home arrangement into their role going forward.

So we're hearing the same from other employers.  There's a number of reasons behind that.  And some of when we looked at our own results, it was really around the commute to work was probably people's biggest concern when it came to coming back in.  And the other thing was the loss of flexibility.  They didn't want to give up the flexibility they've gained while working from home.  So I think that is probably your more permanent, you know, and obviously with second waves, et cetera, where we still have very heightened concerns around the health issues.  But beyond that, I think you'll see that people have now realised that not having to do that commute.  They've got so much more time in their day or there's time to spend doing things with their family or of their choice and they're finding it more productive because they can be more flexible and they don't want to give that up now.

I think you will see some changes and certainly maybe the way workspaces are configured that will have to change, but it might be a gradual reduction.  As leases come up for renewal you will see those that do potentially assess, do we still need this space or do we want a more dispersed workforce?  So rather than having everyone in a central spot, maybe we have a bit more of hubs out in different places.  But certainly, the key element now of getting offices back up and running is really around meeting the social distancing requirements and I know certainly landlords and employers are really having to deal with that right now.

Ken Morrison

Yes, as Sian says, there's a couple of different forces at play here.  So one is this master class the country has just had in working remotely and any, you know, last sort of naysayers that said it couldn't be done.  It has been shown that actually it can be done.  But then there is this, you know, why do people get together?  What is it about proximity that is good for business?  And there is hard realities that when people are together, they are more creative, they are more productive.  They problem solve better.  They build culture together.  Younger team members learn more by just observing more experienced team members or their managers go about their work.  That's the reason why businesses collocate their people together.

Sian Sinclair

I was going to say you now survey the two reasons that people wanted to get back to the office.  The two highest ones was seeing friends, colleagues, and having that ease of collaboration again, and that's what people are missing.  So I don't think you'll see the permanent work from home, but definitely just know we're going to see a bit more of a mix, I agree.

Ken Morrison

I guess there’s these counter forces and how that plays out in terms of what's happening in CBDs is, you know, we'll have to see, but there is this strength of being together and it's absolutely completely vital to business success.  There are those out there who say, well, this is the death of the CBD or the office building or whatever, but that's clearly not the case.  And there will also be the case that some tenants, while they might have more people working from home on any given day with more flexible working arrangements, they're probably also going to need more space.  So we've seen over the last 10, 15 years, there's this March of tightening up workspace ratios and it's highly likely that that that tightening of workspace ratios will now reverse out again.  So there will be a number of different forces, which will be at play, which will be drivers for the office market over this next couple of years, probably as we recover from this virus.

But probably, the other thing to say is, you know, Australia is now in recession.  The world is now in recession and in recessions you do have a drop in demand for office space and, you know, everyone's expecting, we'll see that impact come through as well. 

Velvet-Belle Templeman

Ken, are landlords reacting to these changes as yet?  Or are we still in the wait and see phase? 

Ken Morrison

Well, I think landlords are making all those arrangements for people to return to their office, their tenants, to return to the office.  And of course, if we're talking about what's going on in Perth or Adelaide, then it's much more advanced than a Sydney or a Melbourne.  So there's a lot of focus going on there.  I think two good things about the situation we find ourselves in compared to say the GFC is that one is office markets are actually quite tight, particularly in Sydney and Melbourne.

So vacancies that the Property Council measured in January in Melbourne was just 3.2 per cent, and in Sydney 3.9 per cent, so incredibly tight vacancies.  So if you were going to have a shock come by then, at a time when vacancies are so tight, it’s probably a good time to have it.  And the second thing is with the new supply that is coming on the market, which is predominantly overwhelmingly going to those very tight markets, so it’s overwhelming going to where those markets need it most, is the pre-commitment level.  So again, we're not building much office space on spec, companies have already made commitments to those buildings.  I think there's less risk about those big dynamics of the supply side than there might have been if you look at previous big economic shocks and what happened in the office market.

Velvet-Belle Templeman

Sian, will be seeing more office sharing spaces like WeWork or more hubs outside of city centres?

Sian Sinclair

Well, I think it's certainly the case that many large employers who are generally large tenants, are now looking at whether there's a better way in keeping their workforce productive, engaged and if the writing's on the wall about wanting to be closer to home and the commute, and how can we deal with that?  I think you will see less people in a centralised office on given days.  And initially that's going to be forced because of social distancing.  So you're going to have rostering systems almost, but in the long term, those who have adapted well to the work from home and the flexibility of that, and as long as they continue to be productive employees, I think employers will support that.  You know, maybe it is a bit of a shared option that might be closer to home that kind of takes the commute out of their day.

And they're able to, you know, drive or walk to these places that are more, I guess, in the hubs outside of the centralised big office, where everybody streams in on a daily basis.  But you know, of course when you've got shared environments, there's less control that the employer has over those.  So how comfortable they are with mixing their people with employees, from other businesses, which, you know, whilst it provides an environment for collaboration, but there's less control over the practises, and the COVID safe practises and keeping those employees safe.  But I think you will find it will out that there'll be maybe less people in the offices on any given day.  So that does present quite a significant cost saving.  If people think about space that they're not using or desks that are really well underutilised, but the alternative there is for the employers to sort of collaborate with landlords to kind of reimagine how the space gets used.

And maybe it's something that could enhance the employee or even the client's experience in enticing them to come in.  We are also going to be having to entice clients back into our office spaces to continue relating and interacting with them on the way that we have.  So, you know, we need to make them feel safe as well as our employees.  But I think certainly subletting and office sharing, if it's going to allow people to get into facilities closer to home that allows that concentration, particularly school holidays, no distraction of kids, et cetera, but it does take out a chunk of that commute into the central hub.  I think that could be something that employers might look to.

Velvet-Belle Templeman

Ken, looking at the impact on the pipeline for current and future commercial developments, for example, major developments, such as Quay Quarter in Sydney that have been years in the making.  Are there any doubts about filling these spaces or projects being pulled?

Ken Morrison

Well, I think what you've seen with the major new office buildings coming through is there's a high degree of pre-commitment in those projects, which de-risks those projects and we’re yet to see any of those major projects be cancelled, which were otherwise scheduled to come out of the ground in the next couple of years.  So I think we start from a good position.  I spoke earlier around the incredibly low vacancy rates we have in Melbourne and Sydney.  Look, at the margin, of course, you will see some new projects not go ahead.  The Property Council figures show that over the next three years, we expected about 1.3 million square metres of office space to come into CBD markets over the next three years, 50 per cent of that number was going to happen this year.  So obviously if it's being delivered this year, it's locked and loaded. Which means that there's not much supply across our CBD markets, which will be landing in 2021 and 2022.  And indeed, of that supply that is coming in, most of it is hitting those very, very tight markets of Sydney and Melbourne. 

So, you know, what we're not likely to see is big changes in office markets because of a massive amount of new supply that most likely there might be some of that supply in out years, which will drop off, but we won't see supply at large levels, hit a market at a time when demand may well be lowering or may well be being questioned because of COVID related impacts.

Velvet-Belle Templeman

So if you're a landlord or developer, Sian, what are your options?

Sian Sinclair

Well, I mean, it's early days, but traditional investors in this asset class are usually, you know, if they've got projects that a lot of work that's gone into them before work starts on the ground.  But you know, maybe in this current market, they're having a look at those just to see if there's any tweaks required, and to what extent commercial office is fitting into that and is there a re look at that?   As Ken says, there's still going to be demand and while I am aware of a number of planned office developments for future years, that sort of had just been shelved or, you know, a couple have actually just being scrapped, for now thinking about, well, let's place our money elsewhere in the shorter term.  But assessing, I guess, the forward demand for those types of projects, you know, it's going to take a wait and see around, because we are talking about this move has been a heightened reaction because of the health crisis. 

And once we have understood and that's kind of incorporated into our lives and we're feeling a bit more comfortable and safe, then it is more about that lifestyle choices about whether people are choosing to use an office as their workplace on an everyday basis.  But we are talking about significant long-term assets here.  So maybe we end up with more tenants that have smaller footprints rather than those key tenants, which have their entire workforce in the one spot.  Maybe there is a bit more spread and you just end up with more tenants filling the same space, or I guess thinking around, you know, the underutilised space or spaces like the, you know, the gathering spaces in foyers or what used to be, you know, the communal type spaces.  I think you'll see a bit of innovation maybe about how those spaces now start to look and in design we’re looking at, you know, they talk about the clockwork movement around buildings so that you're not entering and exit at the same place, corridors being one way, et cetera.

So I think you'll see incorporated into the future design, this sort of healthier aspect and a little bit more of the separation of people, but, you know, as Ken was talking around before, it's really coming back to that offices and workspace as a places for collaboration.  I think people will miss that.  I think you'll find it'll move to more of a mix and we'll have a very limited number who do, you know, permanently work remotely.  And maybe it's an opportunity for refreshing existing older buildings, you know, seeing how that could be restructured to suit the needs now rather than the traditional office space.  It’s always going to continue to evolve as our practises and our trends kind of, as we develop and what the employees and therefore, the tenants are wanting.

Ken Morrison

I think the other thing that’s likely to get a push along from this experience is wellness as an issue, which was already a focus for many office landlords and some major tenants.  But I think the combination of the COVID experience, what we saw at the start of the year with Bushfires and the terrible smoke impacts that were impacting a number of our cities.  Wellness really is likely to become a more heightened demand, particularly for premium and quality stock in new projects.  So I would expect that will also I get a kick along from this experience,

Velvet-Belle Templeman

Maybe a little future gazing now Ken, do you think the Australian office market will follow what happens globally or are there unique aspects to our market, that mean we'll see some different outcomes here?

Ken Morrison

I think fundamentally it will be what happens with the economy and, you know, so far so good in terms of Australia's dealing with the health crisis and of course, our economy is being impacted quite significantly.  The impacts we are seeing in many comparable countries are far greater.  So if we can hold that, we can continue to manage this health crisis well, and therefore support the economy through this impact zone, then I think that will be to our benefit.  The other thing which is still broader macro related is, is our country going to seize the moment and enact the reforms that we need to drive productivity, to drive prosperity and drive growth?   We've seen the Prime Minister say that Australia needs growth up at around 4 per cent to recover from the COVID impact.  And we've had the very, very clear warnings from the Governor of the Reserve Bank to say that there is no way we're going to do that unless we embark on quite a series of economic reforms in this country, the sorts of things which have been sitting in the too hard basket for a long time.

So, you know, that's yet to be seen how brave we're going to be as a country here and hopefully we'll pick up a number of those things.  So if we can get the economy recovering, but then also the economy firing and we continue to do well as a country in comparison to other countries, then I think we'll be setting ourselves up for a much better future than what we'll see elsewhere.  I think what we will continue to see is the Australian office market being underpinned by offshore capital as well as domestic capital.  So I think that role of international capital in the Australian marketplace will remain really core.

Sian Sinclair

Well, Ken, it's interesting obviously with the current restrictions that are in place from the Foreign Investment Review Board in relation to the ability for foreign capital to come in and I guess the brakes are on there.  So I guess the sooner we see that lifted will be to the benefit of continuing the project and investment to occur.

Ken Morrison

Yeah, I think that's very right and we've got to remember if we want the world's best capital to create great assets for Australians, then we need to make sure we've got the right regulatory structures.  Now the federal government is undertaking a review of FIRB arrangements to bring national security issues much more to the fore.  But you know, most of the foreign investment we're talking about into office buildings and, you know, is not security impacted or it doesn't have any security related issues.  So, you know, we really need to get those arrangements normalised.  So we can have that welcome mat out to foreign investment and have another look at some of these ridiculous taxes that we've put in place around the country, which ward off foreign investment in things like commercial office buildings, which is something we're going to need more of.

Velvet-Belle Templeman

Sian and Ken, thank you, for your time.

Ken Morrison

My great pleasure.

Sian Sinclair

Thanks Velvet-Belle.

Velvet-Belle Templeman

You can find further information on how COVID-19 might affect your business and assistance is available to you on the Grant Thornton COVID-19 hub at www.grantthornton.com.au/covid19.  My name is Velvet-Belle Templeman, and you're listening to Boardroom.Media.