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Work-from-home trend threatens obsolescence for old commercial buildings

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2023-07-14

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The ongoing work-from-home trend is prompting commercial landlords and tenants to reassess their needs, potentially rendering some buildings obsolete.

In the new world order of commercial property, high-quality and well-appointed offices are attracting tenants, while older, tier-three grade buildings on the outskirts of cities face an uncertain future.

According to Michael Cook, Investa group executive, the office market is undergoing a significant structural change. Last year, the focus was on migrating from old buildings to new ones, but this year the emphasis has shifted to amenity. Buildings in prime locations, equipped with up-to-date facilities, close to transportation, dining, entertainment, and fitness options, are the ones thriving.

On the other hand, commodity-grade properties in Sydney's western corridor or Melbourne's Bourke Street or Docklands precinct are struggling to find tenants.

Investa group executive Michael Cook comments, “Only those buildings in the best locations, with the most up-to-date end-of-trip facilities, close to transport, restaurants, bars, hotels, and gyms, are surviving. The A and B grade properties in Sydney’s western corridor or in Melbourne’s Bourke Street or Docklands precinct – the commodity stock – is doing it really tough.”

Data from global real estate services firm JLL reveals that the national office vacancy rate rose by approximately 70 basis points to 14.4% in the three months leading up to 30th June.

With half of the workforce working remotely, landlords are under pressure to provide incentives such as premium in-house facilities, free parking, or rent reductions to remain competitive.

Without these inducements, tenants are increasingly opting for lease deals in high-end skyscrapers, leaving older buildings vacant.

Josh Rutman, head of Victorian capital markets at JLL, characterises the market as one of haves and have-nots. Some landlords continue to invest in their buildings to ensure they remain relevant and offer quality service and amenities to tenants. Meanwhile, others are edging toward obsolescence, which forces tenants to seek better accommodation. These owners face difficult decisions about the future of their properties.

Winston Sammut, property director at Euree Asset Management, who is running the fund with ex-AFL footballer James Hird, said newer quality office space will be in demand, as opposed to older-generation, lower-quality buildings which are difficult and costly to retrofit.

“The onus now is on landlords being able to meet tenant demands. Those landlords that do, will benefit as a result,” Sammut said. “What we are seeing is that tenants are now placing their focus on several other measures than those that prevailed in the past.”

Adding to the pressure is the push from the Community and Public Sector Union for flexible working arrangements for public service employees. The Financial Sector Union has joined this initiative and taken the Commonwealth Bank of Australia to the Fair Work Commission after the bank ordered staff to return to the office for at least half of their working time from 17th July.

Despite these challenges, the Commonwealth Bank of Australia has shown confidence in the Melbourne office market by leasing 15,000 square metres at Cbus Property's new commercial development, 435 Bourke Street, in 2026. This move will result in the bank vacating its current premises at 727 Collins Street.

Michael Cook highlights the changing dynamics of office utilisation, noting that satellite offices have become redundant as the hub-and-satellite model has been replaced by a combination of hub and home. Suburban office locations, such as North Ryde, Chatswood, Parramatta, Hurstville in Sydney, and Box Hill, Dandenong, St Kilda Road in Melbourne, are experiencing increased vacancies, raising doubts about their continued viability.

Winston Sammut, property director at Euree Asset Management, emphasises that newer, high-quality office spaces are in demand compared to older, lower-quality buildings that are challenging and expensive to retrofit. Landlords now face the responsibility of meeting tenant demands, and those who succeed will reap the benefits.

"The onus now is on landlords being able to meet tenant demands. Those landlords that do, will benefit as a result," Sammut said. "What we are seeing is that tenants are now placing their focus on several other measures than those that prevailed in the past."

Tenant priorities have shifted towards factors such as environmental, social, and governance (ESG) credentials and creating a more appealing working environment to entice employees back to the office.

Andrew Ballantyne, JLL's head of research - Australasia, highlights that while workforce flexibility remains crucial, organisations investing in amenity-rich workplaces with strong ESG credentials will be better positioned to attract and retain knowledge workers. Most executives recognise the limitations of the current hybrid workplace model and acknowledge the need for change to support in-person collaboration and productivity initiatives.

In this evolving landscape, commercial landlords and tenants are navigating a new reality, where premium office spaces with modern amenities reign supreme, leaving outdated buildings on the fringes facing uncertain futures. Adaptation and investment in meeting tenant demands for superior workplace experiences and sustainability will be key to success in the changing commercial property market.

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