Working from home: A new challenge for Asia's office landlords

"Employees can continue to work from home forever." Jack Dorsey, CEO of Twitter and Square

"We will allow 75 per cent of employees to work from home by 2025." TCS, largest IT services company in India

DEVELOPED economies are predominantly fuelled by the service sector (as against manufacturing), and with rapid technological advancements, it is easy to do more work from home. Does the Covid-19 pandemic spell "the death of the office"? We investigate here.

Offices are one of the key components of commercial real estate. In Asia, the top six Grade-A office stock in the major cities (Hong Kong, Singapore, Tokyo, Sydney, Shanghai, Mumbai) have a combined market capitalisation of US$0.8 trillion as at December-2019, based on Morgan Stanley Research estimates.

Many investors have wondered what the new normal for offices will become after the Covid-19 pandemic. The concept of "Work From Home" (WFH) means different things to different people. For employees, it is flexibility; for employers, it is cost saving, and for landlords, it could mean rising vacancy rates and declining rents. One thing is for sure: it will result in more people working from home even after Covid-19 is gone.

For investors, the key is to find cities/stocks that have already discounted the worst-case scenario. For example, in the first six months of 2020, Hong Kong saw an office spot rental decline of 13 per cent while Tokyo saw a 3 per cent increase, though the supply increase in Tokyo was much greater than that in Hong Kong. This implies that stocks of office landlords in Hong Kong are more attractively priced than those in Japan. Overall, we expect tenants across Asia to surrender 3-9 per cent of existing office space permanently, resulting in a rent decline of 10-15 per cent over the next three years.

To understand this trend, we at Morgan Stanley surveyed thousands of office workers in different industries in Hong Kong, Australia, the UK and the US and concluded the following:

We have sought to quantify the likely impact of WFH on office vacancy rates and rents by first assessing the rental outlook without factoring in WFH, then looking at the likely WFH impact based on five key drivers:

In addition, we looked at any potential counter-impact caused by social distancing and desk sharing. Demand for flexible (Flex) space in APAC could re-accelerate in the wake of the pandemic as occupants increasingly value flexibility in light of rapid changes in business conditions. We think demand for flexible space will grow across most markets in APAC over the next three years.

Singapore is one example in which the negative impact from WFH is likely to be offset by effects of de-densification and supply removals. We think market concerns over the structural headwinds to office demand may be overdone. We forecast Grade A office spot rents to decline 15 per cent in 2020-21, before rising 5 per cent in 2022. We think the net 10 per cent decline in rent over three years will be underpinned by island-wide vacancies increasing from 10.5 to 12.5 per cent through this period, as demand trails a below-trend net supply outlook.

After factoring in stock removals for redevelopment, we estimate total office stock will grow just 2 per cent over three years. But on the demand side, we expect zero net absorption as tenants return space in 2020 amid a likely economic recession. In our bull case, we think office rents could grow 15 per cent in 2020-23, and in our bear case we see a decline of 30 per cent.

Singapore's office worker population would prefer to spend 28 per cent less time working from office premises, according to a survey undertaken by Engagerocket.co in June 2020. However, we believe that at least in the near term, the need for more space to ease office density could be enough to fully offset the reduction in demand as more office employees work from home.

Despite all the concerns highlighted, the impact may be slow for four reasons: