Dude, where’s my office?

Now that remote working has become part of SA Inc’s lexicon, corporates may consider cutting back on office space to reduce monthly overheads.

The work-from-home trend will place further pressure on an already oversupplied office sector — over the past decade, national office vacancies have doubled, reaching close to 12% in the first quarter of 2020, according to the latest figures from the SA Property Owners Association.

Kundayi Munzara, director of property asset manager Sesfikile Capital, expects vacancies to rise significantly in the short term on the back of the SA Reserve Bank’s forecast that the economy will contract 7% this year. He says they will become particularly pronounced in the lower B-and C-grade space (mostly buildings older than 10 years), where tenants are typically smaller businesses with limited balance sheet capacity to withstand a recession.

But Munzara dismisses the notion that traditional office buildings will become obsolete simply because more people are working remotely. "Longer term, we expect only about 20% of the global workforce to work from home — or be allowed some [variation] of this," he says.

"SA is likely to follow a similar trend."

Darryl Mayers, joint CEO of Investec Property Fund (IPF), believes existing office tenants will need 30% less space if the work-from-home trend gains traction. But that doesn’t mean vacancies will suddenly shoot up 30%, as traditional lease agreements lock a tenant into the contract, usually for between three and five years.

Even so, IPF’s latest results underscore just how weak the office letting environment is. In the year to end-March, rents on office lease renewals fell 21%. That compares with a drop of 1.2% and 8% for IPF’s retail and industrial portfolios. Though it’s too soon to say how things will play out, Mayers believes office rents could drop another 10%-20% over the next year.

Estienne de Klerk, CEO of Growthpoint Properties, SA’s largest commercial landlord, agrees that the office market will come under further pressure in the second half of 2020 — less because of changes in how people work and more because of the economic impact of the lockdown. "It’s likely that many businesses will fall over in the coming months, which means reduced demand for office space," he says.

The flip side, says De Klerk, is that some companies may need additional space to meet social distancing requirements.

Redefine Properties COO David Rice makes a similar point. He says the work-from-home trend is unlikely to have a long-term impact on office take-up rates. None of Redefine’s larger tenants have so far indicated they want less space.

Rice says that prior to Covid-19, corporates had been steadily reducing their space requirements as private, enclosed cubicles made way for open-plan offices. Over the past decade, the average space-per-person allocation has halved to about 5m²-6m². "So there’s little room for corporates to cut the ratio further, given new social distancing requirements," he says.

Besides, Rice says, typically only 15%-20% of office leases come up for renewal in any one year. That means a relatively small portion of landlords’ tenant bases will technically be in a position to cancel their leases or cut back on floor space in the next 12 months.

Rice expects that smaller tenants, including small and medium enterprises, will be looking to make such cuts. Much of the space in Redefine’s office buildings has already been split into smaller parcels. Where, say, 1,000m² was leased to one large tenant five years ago, that space has already been reconfigured into multiple 20m²-30m² spaces to cater to smaller users. Rice believes this trend is likely to accelerate.

One thing, at least, seems certain: landlords will have to offer more flexible terms if they want a larger share of a shrinking tenant pool.

"The reality is that landlords have to look at any angle they can to generate an income on vacant space," says De Klerk. "We will all have to become smarter and find ways to keep existing tenants and lure new ones."

He refers, for instance, to redeveloping empty offices for residential use, or as schools, colleges or health-care facilities — "provided one can get an acceptable return on conversion costs". Alternatively, landlords could drop rental prices or offer incentives, such as higher fit-out and installation allowances, he says.

Redefine has already introduced "out" clauses in its new lease agreements, giving tenants the option to cancel 12 months into a three-to five-year term, or to give three months’ notice at any time.

Rice believes the days of locking tenants into multiyear leases with no escape clause are over. There is a caveat, though: "To mitigate landlords’ increased risk of early termination, tenants will either have to forfeit part of their installation allowance or be prepared to pay a higher rental."