Changes we saw in the Australian office market during 2020.

In this interview, we sit down with Julian Kurath, director at LPC and expert in the Australian office market, to chat about the changes seen in 2020. 

Question: Going forward, how do you see work from home and the office fitting in? 

Julian: Initially going into lockdown, it seemed that working from home would be a short-term solution to ensure business continuity. As time progresses, it’s no longer short term, the change is becoming far more structural.

One of the key things we’ve found is that there are both pros and cons to working from home. Commute times reduced for employees, combined with and the potential for savings from reduced office footprints, are tempered by impaired collaboration and upskilling of inexperienced employees and graduates, and the challenge of driving increased productivity.

The office will always play a key part for businesses, and it’s likely we will see on average employees working between 2-4 days in the office, and the remaining days from home. However, some roles may be more suitable for 100% work from home, and others may require 100% work from the office. 

Space savings and the resulting financial savings will be dependent on how a business can structure the working week. There is no point having everyone coming in on a Tuesday, Wednesday and Thursday whilst occupancy on Monday and Friday is minimal.  It is important to flatten the occupancy by allocating office days, modifying the office design, and using booking apps such as GoSpaces to drive efficiencies that result in floorspace savings.

Question: What impact has the pandemic had on tenants? 

Julian: A business’ location and surrounding amenity has always played a big part in how to keep and retain good staff. Whilst the CBD offers great amenity and access, Covid has caused many businesses to ponder the question if they need to be in the CBD, particularly if their clients are adopting a work from home policy and attend the office less frequently, combined with a far greater acceptance and take-up of online or virtual meetings. 

We’ve seen companies ranging in size, consider a move out to the metro office areas where the rent is significantly less than that of the major CBD’s. Whilst this will drive short term occupancy savings, it will work for some, but not for all. 

On the other hand, with vacancy increasing in the CBD and landlords accepting more favourable tenant terms, it creates the opportunity for metro tenants and those located in lower-quality buildings to upgrade. Essentially, it is the ability to move to a better grade space with more bang for your buck. We have seen this cyclical change between CBD and non-CBD markets across the country during the recovery phase in previous downturns. There has also been a large increase in sublease space across the country, with businesses looking to recover their costs for space which is no longer utilised and therefore necessary.

As for returning to work, smaller groups have been far more comfortable due to greater flexibility and ability to be nimble. Despite a push from senior management to return, larger companies have been far more hesitant. They are often answerable to head offices based overseas - where Covid is more rampant - effectively overriding the local executives calls to return. There is also an additional level of reputational fear, as no company wants to be linked to a second Covid wave or outbreak. 

Question: Overall, what has this meant for rents and incentives? 

Julian: With occupancy levels across our cities remaining low, it is likely that we will continue to see an increase in subleasing vacancy, as well as direct lease vacancy as these leases expire or are surrendered back to the landlord. There are two slightly different motivations between a tenant disposing of space and a landlord leasing direct lease space. On one hand, a tenant will look to recover costs by historically being, aggressive on rents and incentives to attract tenants. 

On the other hand, a landlord’s long-term driver is growing rents, and consequently growing the building’s value and therefore investor returns. They take a completely different view to a tenant and traditionally less willing to reduce face rents, preferring to increase the incentives on offer. Despite this, there comes a point where landlords have to compete to win new tenants. This is when we will see the true market trend in relation to face rents and incentives, and we are beginning to see that occurring now. With many businesses unlikely to experience significant growth in revenue and profitability, there has also been a big push to reduce annual rent increases. Whilst they have fallen, some landlords have looked to artificially keep them high by offering additional incentives to compensate. 
 

Question: How are offices evolving to meet new tenant demands?

Julian: This is the million-dollar question, but overall, it comes down to flexibility. The first area is the accelerated movement towards agile working, which has become far more common over the past few years. With agile working, employees don’t “own” a desk, but have a booking system in place to allocate one when coming into the office. These booking systems also allow users to mark spaces for cleaning, ensuring a Covid-safe environment. 

In terms of physical layout, there is also likely to be a stronger emphasis on collaboration areas, allowing teams working together on a project to use their time in the office effectively.  We will see more AV meeting rooms and facilities available for calls, with many calls even when staff are in the office still being carried out online. For example, despite most of us, the LPC staff, being back in the office, our team meetings are all online to allow those working from home to dial in.

Question: What have been some of the changes to leases agreements as a result of the pandemic? 

Julian: The biggest changes have been “utilisation” clauses and the increased need and demand for expansion, contraction, and early termination rights. One of the reasons why businesses have been reluctant to commit to a transaction is a sudden lockdown which prevents them from utilising the office. A utilisation clause protects a tenant when not being able to utilise their space due to a government order, and guarantees an equal sharing of the costs between the tenant and the landlord.

Additionally, flexibility has also become extremely important, particularly through expansion, contraction, and early termination rights. Expansion and contraction rights allow for businesses to take up additional space or drop excess space and can be used both before and after a lease has commenced. They’re particularly beneficial for larger tenants who might negotiate a lease commencing in a year’s time, but have a fluctuating headcount.  Termination rights allow for lease agreements to be fully terminated early and typically come with a pre-agreed break fee, being a pro-rata repayment of the incentive received upfront. While there is a risk on the landlord side, there is a commitment to work with tenants in order to facilitate commitment to space now, as opposed to it sitting vacant. 

Question: Will we see less flexibility going forward when we hopefully have a vaccine? 

Julian: I don’t think so. Even with a vaccine, the pandemic has put its stamp on how we utilise our offices and working from home is here to stay more so than it was pre-Covid. This creates additional vacancy and ultimately drives more tenant favourable clauses and outcomes. 

Question: What advice would you give to business leaders and CFO’s currently evaluating their office requirements? 

Julian: The most important area is drawing a line in the sand to determine the headcount and what size the business will be. There is an opportunity to drive very favourable lease terms, but as things progress and become more certain, that opportunity may reduce. Once a business makes that commitment, we can build in the flexibility through utilisation clauses and termination rights, and allow a tenant to lock favourable terms, ultimately benefiting from a tough situation. 

We’re expecting that there will be more larger transactions occurring in the coming months and into next year.  

How can LPC help? 

At LPC, we help tenants across Australia and New Zealand with their commercial real estate needs, including transaction advisory, portfolio management and project services.