As early as January 2021, less than a year after the Covid-19 pandemic erupted, the average return-to-office rate – the office occupancy rate relative to pre-pandemic levels – in the Asia-Pacific already stood at 58 per cent. By November 2022, it had shot up to 80 per cent.
Fast forward to today and this is a level that is the envy of most office landlords in the United States. While some employers have taken a more aggressive approach to forcing staff back to the office, the shift to remote work in the US has become entrenched. According to Kastle, average occupancy rates among 10 leading US office markets have struggled to surpass 50 per cent since the end of 2022.
By contrast, with the exception of Australia, working from home was slow to take root because of cultural and economic factors. Yet even though the region’s offices were largely spared the severe disruption from the move to working from home, the sector faces acute cyclical and structural challenges.
In the investment market, Asian office valuations have not adjusted sufficiently despite the sharp rise in interest rates, making higher-yielding and more resilient segments of Asia’s commercial property market more appealing to investors. “There’s a stronger push to diversify [away from offices],” said Karen Wan, senior director of international capital coverage at JLL in Singapore.
However, it is in leasing markets where the challenges facing Asian offices are most acute. The fundamentals of the sector, while stronger than in the US and Europe, are under severe pressure. This is partly because of a supply boom. New completions accounting for 7 per cent of the total grade A office stock in the region are expected to be delivered this year alone, according to CBRE.
While leasing demand in India remains buoyant, underpinned by the country’s thriving offshoring and outsourcing industry, it is subdued elsewhere in Asia. Although Seoul and Singapore continue to benefit from tight supply, the overall supply-demand imbalance across the region has pushed up the average vacancy rate and exacerbated the decline in prime rents, which have fallen for two straight years.
The supply boom comes at a time when companies are prioritising cost control. Many large multinational firms are downsizing or consolidating their real estate, while other occupiers are wary of incurring heavy capital expenditures once their leases expire.
Limited appetite for expansion has meant that renewals are driving leasing demand. Even when tenants relocate, this usually involves some form of consolidation or downsizing, creating the false impression that the shift towards remote working has had a bigger impact on Asia’s office market. “The reality is that these moves are driven mainly by the downturn in the business cycle,” said Tim Armstrong, global head of occupier strategy and solutions at Knight Frank.
Another crucial driver of leasing activity is the “flight to quality” as tenants favour newer, well-located offices with plenty of amenities and strong environmental credentials. The preference for high quality buildings has had a discernible impact on rental values and occupancy levels, creating a divergence between best-in-class and other grade A offices.
The flight to quality trend is attributable to several factors. First, Asia’s office markets have become increasingly tenant-friendly, with rents in many markets still below pre-pandemic levels. Even in markets such as Sydney where rents have been rising, landlords are offering prospective tenants more incentives, such as rent-free periods, to sign a new lease.
Many occupiers are capitalising on the sharp fall in rents to relocate to districts, mostly in core locations but also in emerging ones, where there are more high-quality buildings. “This is a great time in the cycle for tenants looking to upgrade,” said Richard Stevenson, head of office occupier for Asia Pacific at CBRE.
Second, although working from home is less prevalent in Asia, the health and well-being of office workers has risen in the commercial property agenda, putting a higher premium on building design and location. Collaborative and relaxation spaces, healthy food services, gyms and outdoor areas are high on the list of amenities needed for employers to recruit and retain top talent. This favours buildings with large and efficient floor plates, flexible space options and good transport infrastructure.
Third, and most importantly, demand for sustainable real estate has increased sharply as environmental, social and governance commitments emerge as one of the most important criteria for leasing and purchasing commercial property. Yet as CBRE notes, the share of green-certified office stock as a proportion of the total office stock in Asia stood at just 44 per cent in November 2023.
It is precisely in those markets where the supply of best-in-class sustainable buildings is most constrained where the impact of the flight to quality is most apparent. The difference in occupancy rates and rental values between the best prime office buildings and the rest of the grade A stock is sharpest in India and China.
This suggests a bifurcated office market in Asia has begun to emerge, in which the top tier of prime buildings is outperforming the rest of the market. It is also a taste of things to come in the transition to net-zero carbon emissions by 2050 and as older, lower-quality and less energy-efficient offices lose out in the flight to quality. “Certain buildings will not be fit for purpose,” Stevenson said.
Asia’s office market had a good pandemic compared with its US counterpart. It is the post-pandemic era that poses a challenge to the sector as occupier and investment demand focuses on premium buildings.
Nicholas Spiro is a partner at Lauressa Advisory
