After a turbulent few years, there is cause for optimism once more in the office leasing market. Landmark deals such as the announcement last month that Revolut is expanding its office footprint in London indicate increasing confidence in the market. We are seeing increases in tenant demand and downward pressure on the incentives landlords have to offer. Opportunities are out there for those landlords that have good-quality space and are able to offer flexible and fleet-of-foot negotiation.
Data from Remit Consulting from March of this year showed daily office occupancy at 34.1% – the highest level since May 2021 – a sign that the pendulum has started to swing back in favour of face-to-face professional interaction following several years dominated by remote working.
This upward trend has slowly been emerging since the last of the government’s mandatory work-from-home orders were lifted in 2021, but there has been a noticeable acceleration in recent months. Over the past year, there has been a concerted effort from many well-known organisations to get employees back to the office on at least a part-time basis. Research from Virgin Media O2 Business has found that almost all companies (92%) now have some kind of mandatory in-office policy, and two in five have returned to a five-days-in-office work week.
That is then coupled with the increasing demand from younger employees in particular to regain the professional and social advantages that face-to-face working brings. Overall, it is fair to say that those who thought virtual working would kill off the need for offices completely – particularly in professional services and other people-oriented businesses – are having to think again.
While occupancy rates may finally be returning to similar levels to those seen before the pandemic, the market dynamics have fundamentally changed. Employees are used to the comfort, ease and financial benefits of working from home and are demanding high-tech offices that offer serious personal and professional benefits. This has caused many firms to up sticks and actively seek out office space that offers quality over quantity.
The post-pandemic office is changing in other ways too. Sustainability requirements are causing businesses to reassess their options to ensure that the place they call home supports increasing ESG commitments, driven by the demands of environmentally conscious employees, clients and funders. Regulation is also set to tighten around energy efficiency in the coming years, something that landlords must factor in as they modernise their portfolios.
As demand grows once more, there is an opportunity for landlords to put the turbulence of the past few years behind them. To reap the potential rewards, landlords must act now to upgrade their stock to ensure their office spaces comply with changing legislation and provide high-quality, sustainable, working spaces fit for a new-look corporate world.
The ‘flight to quality’ is intensifying
Occupier expectations when it comes to lease agreements are shifting alongside these workplace trends. It was widely reported last year that long-term office leases were a thing of the past, with the average length of leases decreasing by 34% versus the previous four years.
However, a year on, things appear to be shifting again. Inflation has settled down and with interest rate cuts expected to come in the latter half of this year, there is a general sense that some economic stability is returning. Three years out from the pandemic, businesses also now have a much better picture of what working and commuting patterns look like, including the impact in London of the Elizabeth Line and how it has affected where employees choose to live and spend their time. With a more certain picture of what the next few years will look like, it is understandable that some larger firms, such as Barclays, have decided to secure long-term agreements for sites that suit their needs.
It is worth noting that this is not the case for all companies and, for many occupiers, shorter, flexible leases will continue to be preferred. However, one thing that is common regardless of the length of the lease – or size of the workforce – is that the traditional hierarchical landlord-tenant relationship has changed. In-demand occupiers are now demanding far higher quality space, with more flexible terms. Low-quality office space is becoming harder to let as tenants increasingly seek the most “bang for their buck”, often preferring to stretch their budget to take the slightly higher priced option in the pricing category above the one they would traditionally have pursued. Badly located, poor-quality, poorly connected and energy-inefficient units will become harder to let, meaning portfolio managers must immediately focus on upgrading their stock to ensure they meet heightened demands.
Sustainability will begin to pay dividends
Another requirement closely linked to quality – and now often a determining factor in negotiations – is the sustainability of office spaces.
Businesses have increasingly set clear targets for reducing their carbon footprint and ensuring they have a positive impact on the planet. Sustainability was a key factor in Winckworth Sherwood’s decision to move to Arbor in Bankside Yards, SE1, over other equally suitable and prestigious offices and, as businesses increasingly put ESG commitments at the forefront of their business strategies, this is understandably influencing their choice of location.
As sustainability moves away from being a “nice to have”, it is vital that portfolio managers adopt clear strategies for improving their eco credentials, or risk their assets becoming undesirable.
At the most basic level, they must consider how they plan to ensure their spaces will continue to meet the changing requirements around minimum energy efficiency standards. Commercial properties’ minimum energy performance certificate ratings are set to rise to C in April 2027. A further rise to a minimum energy rating of B is then due to apply in 2030, although it remains to be seen how the new government may alter these timelines and whether it can afford to risk the fallout of increasing the minimum rating to B.
Regardless of regulatory demands, current forecasts suggest that low-carbon office space is set to offer a significant return on investment in the coming years. Data from JLL shows that supply of low-carbon space is struggling to keep pace with demand. In London, low-carbon demand is expected to exceed supply by 35% by 2030. This demonstrates a clear opportunity for landlords and a need for them to ensure they get their properties up to the highest environmental standard as quickly as possible.
Ensuring offices are constructed and fitted out to a high environmental standard will put landlords on the front foot when it comes to negotiating contracts with clients, with the lack of supply meaning many tenants may be open to committing to longer leases.
Succeeding in a changing landscape
The office leasing market is undergoing a transformative period driven by hybrid working patterns and the dual imperatives of quality and sustainability. Landlords who invest in high-quality, high-tech, environmentally conscious office spaces stand to benefit from the growing demand for such properties.
As firms adjust to post-pandemic working patterns and prioritise ESG commitments, the opportunity for landlords to secure long-term, profitable leases is clearer than ever. By embracing these changes, upgrading their portfolios accordingly and having a keen understanding of occupier demands in their leases, landlords can position themselves for success in this evolving landscape.
Andrew Kinsey is a partner at Winckworth Sherwood
