The growing performance gap between new buildings with a high sustainability and experience offering, and ageing offices, is both the biggest opportunity and the biggest problem facing real estate investors right now.

Some buildings located outside main cities are increasingly being overlooked by companies trying to attract workers into central offices and are worth more if sold empty.

Meanwhile, well-located offices with great amenities are massively outperforming.

In this episode, JLL's senior office leasing brokers from Europe, Australia, U.S., and Asia discuss the past year in office leasing, and what's ahead, with Perspectives podcast host Rebecca Kent.

Guests:

Jeff Eckert, president, United States agency leasing

Neil Prime, head of large-scale project leasing, UK

Marie-Laure de Sousa, head of office leasing, EMEA

Alex Barnes, managing director, Hong Kong and Macau operations

Tim O'Connor, head of office leasing, Australia

Rebecca Kent

Hi. I'm Rebecca Kent, host of JLL’s Perspectives podcast.

On this episode, we've got a guest bill that is more substantial than usual. That's because we're aiming to give our listeners a global picture of the state of office leasing at the moment.

And we thought what better way to do that than to round up our experts who are on the ground negotiating those leases from the UK to the United States over to Europe, down to Asia and even further down to Australia where I'm hosting this episode from now.

Without further ado, I'll introduce all of our guests who are my colleagues at JLL.

Marie-Laure De Sousa, head of office leasing in EMEA.

Hi there, how are you going?

Marie-Laure de Sousa

Fine, thank you and hello from Paris.

Rebecca Kent

And Jeff Eckert, who heads up leasing in the United States, in Texas at the moment?

Jeff Eckert

Yes, good to see everybody this morning.

Rebecca Kent

Moving over to Tim O'Connor, who overseas office leasing across Australia, and he's also based in Sydney where it is currently an absurd hour to be recording a podcast. Hi Tim.

Tim O'Connor

Hi Bec, how are you? Really used to being up at ridiculous hours just to keep things nice and easy for Jeff and Neil on the call.

Rebecca Kent

And Alex Barnes, managing director of JLL's Hong Kong and Macau operations. How are you going, Alex?

Alex Barnes

Hey, Rebecca.

Thanks for having me.

Rebecca Kent

Moving over to Neil Prime, who is typically based in London. Neil specialises in large scale project leasing across the UK, but you're not currently in London, Neil, are you?

Neil Prime

No. I'm an hour ahead of Jeff. It’s 6am, I’m in New York City.

My head's my head still in London time, but the rest of it's on New York time.

Rebecca Kent

Thank you all for joining us.

Let's get straight into it.

Neil, I’ll start with you.

Neil Prime

In our market, and I'm hearing in New York it’s the same, the flight to quality just continues and grows as occupiers are encouraging their people to return to work and back to the office. They really are making sure that workers can come to an environment that they want to be in, that they feel productive in and that will attract them back.

We’re seeing a bifurcation of our market between the very best and the rest. In the very best we’re still seeing rental growth and we're still seeing good levels of take-up in what has, I think for all of us globally, been a very challenging year.

But if you're not in that very best bracket, it's a slow, hard grind at the moment.

Tim O'Connor

Neil Prime

I paid Rebecca to let me go first.

Tim O'Connor

Yeah, it was inevitable.

Jeff Eckert

It's not the first time that's happened, Timmy.

Tim O'Connor

Correct.

So that for me is the big one.

It hasn't been a picnic for investors and developers either, because that list of things that occupiers are now looking for and what's driving their decision making, is getting longer and longer, and as the cost of construction and cost of retrofitting buildings is getting more and more expensive, there's a real challenge in all of that for everyone.

Jeff Eckert

I can speak to the United States.

So just a couple data points there that really support what's happening and continues to happen here in the U.S. and supports what Neil was saying as well.

Marie-Laure de Sousa

COVID was the moment in life for every human on the planet that changed a lot of things but concerning commercial real estate it accelerated trends that existed before.

The first one, which is the most obvious for all of us, will be the return to the office.

The global trend is to come back to the office because we know it's a place where we are creative when we are inventing new offers and new services. You can execute a lot of things when you're alone in your house, but it's completely different when you must create new things.

I have interesting stats from LinkedIn:

It hasn’t stabilised, but the big trend is, ‘guys, come back to the office because it's a real social place where we can all create new things for our clients and our services.

The second trend is flight to quality.

It's difficult to have the people coming back to the office, so you must have the best office in the best place in the best location and this is what we found across continental Europe. It means there’s great pressure on delivering quality buildings located in all the CBDs. We have big problems finding tenants outside cities where there are great buildings.

And the third big trend that we have seen post COVID is ESG.

Specifically, this is the way the companies are looking at the future and how they can combine the return to the office, attracting talented people, and being sure that it will be a future building for them and for the planet also.

Neil Prime

I think it's actually a very good point to define quality.

It doesn’t mean new necessarily.

It's a combination of factors that would be great connectivity, great amenity, access to public spaces, and an office building that balances top ESG and a great experience for the people who walk in.

When you combine those things together, that's when you get that massive outperformance compared to the rest of the market.

If you strip any one of those off, then that performance just begins to drop.

So there's a real formula that if you can hit it, your assets are performing really well.

Rebecca Kent

Alex does this all resonate in the Hong Kong market?

Alex Barnes

Yeah, I'd say 70% of it does.

Interesting talking about COVID, Hong Kong was probably the last major market that came out of that.

Our past year would be typified by fits and spurts.

We came out of that COVID mentality and releasing of the masks and travel becoming a lot more of the norm, and international travellers finally coming into Hong Kong.

But then that slowdown in mainland China really hurt demand.

But that demand from the mainland just didn't really eventuate.

We had a lot of wealth management insurance demand in the first half of the year, but it has really tailed off.

The economic stability in mainland China just hasn't really been able to gather any pace.

So that has held back Hong Kong in terms of net demand.

If we think about the challenges that a lot of my colleagues here are talking about with return to office, it's just not as impactful in Hong Kong where we've got multi-generational smaller homes. For this reason there's a lot more of a push factor for people to return to the office so companies aren’t quite providing that same level of flexibility. It's not as big an issue to get people back to the office. It's really just the economic factors in the Gateway City.

Around ESG and that flight to quality, absolutely that exists.

It's really a game of musical chairs here, and there's very little net demand in the market.

Companies are moving from lower quality buildings to better quality buildings and trying to provide that right space for all their talent not to necessarily get them back into the office but to keep them physically planted in Hong Kong in some respects.

So the Hong Kong market has definitely been defined by what's happening in mainland China. We're really waiting for a little bit more economic surety for the market here to see a huge amount of demand.

Rebecca Kent

I just want to move on to this at a more transactional side of leasing and leasing volumes over the over the past year.

Jeff, what’s your take on the level of leasing transactions that have taken place?

Have you been satisfied?

Who is leasing?

Jeff Eckert

So in short, not satisfied. And I'll tell you why.

We have not returned to pre pandemic levels here in the US. Our transactional activity is – I think we have certainly found the bottom – somewhere in that low 40m sq ft of transactions. This is on a quarterly basis and not just JLL transactions.

In a typical quarter leading up to the pandemic we were doing 60mm sq ft of transactions. So we’ve been off roughly 30%-35%.

But the green shoots that we are seeing in the smaller tenant deal flow which is better than it's ever been.

Did it shut down completely? No, but as I look at our tenants in the markets list from market to market here in the U.S., we were probably 50% off normal levels in 2023 when you compare that to 2019.

So I do believe what is happening here in the U.S. right now – and I'm going to touch on return to office again real quick – is that we’re in that final significant push of corporate America employers getting their people back to the office.

We've got 3.5m employees subject to some form of mandate And that's not to say there won't be pushes to get people back in, in future quarters.

But that is a heavy concentration of employees.

My conclusion is that by some time middle of year, employers are going to know what their what their densities are, they're going to know who's back, who's not.

I think that could start to unlock some of these tenant transactions that are sitting there pent up right now.

Tim O'Connor

The challenges we were all talking about on a call last week was for big occupiers being able to find the development opportunities with some certainty that are able to commit to given all the things we've said before: the cost of debt, the cost of construction and various other things that are really starting to have a significant impact on our future supply pipeline over the balance of this decade.

Neil Prime

And I think it's interesting, Tim. There is risk in the development.

Appraisals have been under pressure, so viability rents have gone up. But it's also availability of materials, your supply chain, availability of labour, the additional requirements that have to be designed in, such as ESG and other occupier requirements.

We're actually seeing in London tenants starting far earlier to search for their new future home than they ever have done before. Some of them are signing five or six years before their expiry because that's the window to actually get the buildings built.

And in London, which is a very crowded city, it's not just as easy to go in and build a building like that.

So, it's interesting to see who's active, but also when they actually have the event that is driving the activity.

Rebecca Kent

So if you're putting a requirement out into the market and it's necessary to do that with a longer lead time than you usually would, what are some of the contingencies then that you need to put in place just given the uncertainties that abound at the at the moment?

Tim O'Connor

It's potentially easier from an occupier standpoint if they're dealing with a developer who, as Neil said, subscribes to and understands – which I think most, if not all do – the need for flexibility in their footprint. An occupier needs to have that ability nearer to the completion, to be able to flex that requirement.

I think Marie-Laure made a good point earlier around the trends that we saw that that have been accelerated through this COVID period. Many of them existed prior to it, and in some ways COVID has made that list longer, but it has provided more visibility into occupier requirements around health and wellbeing and the access to flex space and all these other things.

I think the whole new nuance is having flexibility through to an eventual delivery. That's from both parties. The challenge from the developer side is what that cost is and ultimately what that economic rent looks like.

The further out you go the more challenging that becomes.

Neil Prime

Coming back to the question about contingency. To me, there's risk management from both the occupier and investor perspective. It is very, very important, particularly in big projects, longer-term projects, that the occupier and the developer partner more effectively than they maybe have done in certain markets historically – London probably being one of those. That’s so the needs and wants of both sides are understood and it can all be programmed in as you go forward.

Talking about our own experience, we had pre-leased a building in Broadgate for our new HQ here in London and it was probably the first net zero-carbon in operation pre-leased transaction.

The learnings for both the investor developers, British Land, and for us, were huge. Every time you turned a corner, there was something else. A decision here impacted a decision there.

Agreeing a green lease, and all these things, just takes time.

When occupiers are looking in a marketplace, they also have to look at the scale and skillset of who they're going to partner with in terms of risk mitigation. That has never been more important. Occupiers must be having much more open conversations than maybe our market dynamic has previously allowed.

Rebecca Kent

I just want to touch on contraction: portfolio contraction and contraction of spaces, which gets a lot of air time.

But it's not the case that that all companies are looking to contract their portfolios.

Marie Laure?

Alex?

Jeff, maybe you can give us a bit of a picture as to what actually is happening.

Neil, we did speak on a previous call that some companies are actually doubling their footprints

Alex Barnes

I'm happy to go first and bust a few myths.

Rebecca Kent

Perfect.

Alex Barnes

That changed quickly. Hong Kong is often seen as the most expensive real estate market in the world, certainly as a CBD.

When rents come off 35% in that core market, and in some markets a little bit more, all of a sudden you start to see some occupiers taking on a little bit more space, investing in their people and actually looking to provide a little bit more entrepreneurial benefit for some of the functions that they might not have otherwise had operating in Hong Kong because it was such an expensive city.

That's not par for the course. But if you look at hedge funds or wealth management companies, they have tended to make oversized profits over the last few years, and they've been more than happy to continue to gobble up space, to continue to invest in real estate and spend a huge amount of money in providing the right spaces.

So, I think there have been some companies that look to rationalise space. But in Hong Kong that has already been happening over the past decade because of that price.

So we've got a lot of space to absorb and it's likely going to encourage a much healthier dynamic between the developers (it's been typically a developer-led market for a long time) and the occupier, which is more likely going to invest in the right spaces and potentially take more space on as the economy starts to improve.

Jeff Eckert

Yeah, that's really the same thing here in the United States as well.

Some of the numbers that we're tracking with corporate America: if I'm a tenant that is renewing in a building, my footprint on average is reducing by about 10%.

If I'm a tenant that is relocating to another building, we're seeing contraction up to that 20% range. Those are just high-level numbers that we're seeing with respect to tenants reducing their footprints.

But on the flip side of that, you're seeing expansion happen.

I can point to banking or financial services companies that are expanding.

We're starting to see additions to sublease stock slow down and that's because tenants are starting to reabsorb space that at one point in time was put onto the market.

Tim O'Connor

Hey Bec, I know that you are meant to be the one asking the questions, but I'm interested, Jeff, in when you talk about the change on those tenants who are relocating and potentially taking 20% less space, I think back 10 years ago where we saw more efficient buildings or more efficient floor plates and better-quality buildings being built. It was leading to a not dissimilar discount in the total footprint because organisations could use the space more efficiently.

How much of the reduction in that footprint is a result of more efficient buildings or better floorplates, and how much is a function of headcount reduction and or change in the way that people are working, that is, hybrid influence?

Jeff Eckert

It's a good question.

Whenever you're moving to newer construction, nine times out of 10, you're getting into a more efficient: your floorplate design, how you're going to construct your offices, etc.

I think companies that are making the decision to move now are getting more efficient, they're able to chase the flight to quality. Typically, when tenants are moving from one building to another, they're paying more rent, therefore reducing footprint allows them to still fit their office overhead cost within the budget that's been set aside – Albeit the rent is substantially higher when you're moving into a building of quality.

So those are some of the key things that are happening here. They're making the move because they're giving their employees a better experience, too. They're willing to pay the freight, etc. So, it's not all about getting more efficient. That's certainly part of it, but it's also about how we leverage real estate to continue to get our people back in the office.

Rebecca Kent

I'm also interested in that dynamic with some of these older buildings needing to be repositioned to meet sustainability targets and better cater to what tenants and workers want from an office, but building owners balancing that with supply challenges, including the cost of construction and the cost of everything.

Marie-Laure de Sousa

For continental Europe, I can tell you that it could be our major opportunity for the next 10 years and the biggest problem we have today.

In Continental EMEA, you have a vacancy rate of 7.7% which is quite good.

The problem is that everything is concentrated in the suburbs of the cities, everywhere, in all the countries for the same type of buildings: grade C buildings.

The big problem we have today is that the value of the building is higher being empty than knowing how it could be refurbished or with a new tenant.

In a country that I know very well, France, for example, and in the Parisian region, we have 55m sq metres of offices in stock. Eight of them won't be ever rented again. Never. Because they are Grade C buildings, they are not well located.

We are not even speaking about sustainable buildings. We're speaking about energy, there are big gaps and holes everywhere, so we know that those buildings won't be leased again.

So this is the main problem that we find in a lot of countries in continental Europe. The problem is, who is going to pay? If the government are not helping the investors, if globally there is that something to help companies and investors to find a solution. In France, we don't have the right to build any new square meters on free land.

The government are asking us to stop artificializing our lands, so it’s not possible to build new square meters anywhere either in the countryside or even in cities.

So, this means that we have to transform all that stock of buildings that are impossible to let. But who’s going to pay for it? That’s the question, and possibly the biggest opportunity for us all in the next years.

Jeff Eckert

I think that's spot on.

I've got a saying that we are all about to go through the greatest cleansing of office space in our careers.

And I say that because we see what tenants are demanding on where they want to be. They want to be in quality assets.

So in the United States, you've got a 4.8 billion sq ft stock of class, A, B and C property. Two billion of that is B and C property.

I'm not saying that there is not going to be future leasing done on B and C product. There certainly will be. But you have a subset of that 2 billion where I just don't see demand continuing.

That real estate is not going to sit there forever as an empty building. It will be transformed into something else.

We're starting to see buildings get transformed. Or you're going to see those buildings demolished and they're going to come back as multi-family or last-mile distribution industrial buildings.

I think we're in the very early innings of what that transformation is going to look like, but it's coming.

Neil Prime

We're talking about this flight to quality and the best of the best and the higher rents. There is a big segment of occupiers whose business model or margins that they work to don't allow them to pay the very highest rents.

So as a market, how do we accommodate the investment required in buildings – in the UK we have legislation around energy efficiency – at an acceptable price point?

A lot of these businesses support and add to the commercial ecosystems of our CBDs.

There's something opportunistic if people get a bit more creative in terms of how they invest to make sure that it conforms to legislation but is priced in a more appropriate way for those occupiers.

Tim O'Connor

I think the commerce of doing those works is what's really challenging. In Australia, we haven't seen a correction in asset values in that secondary supply.

But I agree with Neil in that there is a massive cohort of occupiers who don't want and don't need to be in those best quality buildings.

The focus at the moment is much more around scope one and scope two emissions. But at a point, scope three is going to start to have a much greater impact on the decision-making of some of those occupiers. There’s a threat you’ll be taken off the preferred vendor list of your biggest clients because you don’t have a building that supports their sustainability goals.

I do think that early mover advantage for investors of those secondary buildings, to be able to reposition them, to be able to capitalise on that, is real.

Alex Barnes

Neil touched upon legislation which I think is really going to define what that medium term outlook looks like.

In Hong Kong we’ve got great examples of buildings that are 30 or 40 years old, prime, CBD locations which have Platinum LEED certifications, and those developers have got great case studies of what they've done to bring those buildings in line as at today.

One of the challenges for any investor, and certainly when you’ve got a prime asset like that – and Neil, I'd love to hear your thoughts on the West End – is that you've got the sustainability component of it, but when you've got a 40 year old building with multiple columns on a floor plate and a ceiling height of a certain grade and without raised floors, there is going to be a capped rental position that those buildings are going to achieve in the future. This is notwithstanding that healthy ecosystem that cheaper buildings provide in the CBD, which I totally agree is critically important.

It will be interesting to see how investors play that role because they’re balancing maximizing long term rental performance against minimal outlay or no rental role for five or six years as they look to redevelop buildings in line with what might change alongside legislation.

Neil Prime

This could apply to every major CBD that we work in. In the West End, where large parts of stock are protected, it's very difficult to create a medium-term vision around a lot of that stock.

What we have actually seen more than in previous cycles for the West End, which is smaller scale than the city – Blackstone preleased a new big building in Berkely Square, we saw KKR do the same in Hanover Square – is scale replacement of smaller units in the marketplace.

We've also seen occupiers moving from that traditional multi-floor, smaller scale portfolio-style occupation to the edges of the traditional Mayfair and St. James’s, where they can get bigger buildings as well.

We talk very passionately about ESG and everything it means for us in our business and our clients.

Let's not disabuse ourselves of the fact that ESG is still not important to certain occupiers out there. Location may override everything. We've had a brilliantly strong relative performance in Mayfair and St James’s over the last couple of years than we had done previously.

We've got to be really careful that we just don't one size fits all in the markets that we work in.

Rebecca Kent

I think you're right. It is easy to focus on the big themes but as you say, there's a whole spectrum of tenants and what they require.

We need to wrap up this podcast here. We've covered so much ground and I look forward to catching up with you again.

Thank you very much, Tim, Jeff, Marie-Laure, Neil and Alex. Take care.