NAB Morning Call

Weekend Edition - 75 percent: The New Normal for Office Workers?

Friday 12th July 2024

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NAB has been looking at a variety of high frequency data sources to see how quickly workers are returning to the office. In this edition NAB’s Tapas Strickland says the trend seems to have stalled at 75% of pre-COVID levels. Credit analyst Evy Noble says this is also reflected in occupancy levels, although there is a large variation from one capital city to another. Phil asks Michael Bush, NAB’s head of credit research, what this will mean for property prices and rental yield. Michael says the issue is exacerbated by new supply already in the pipeline. So how does the market evolve? Will companies try to tempt workers back to the office, or will they downsize and try and spread the days that people choose to work from home?

The detail is contained in the NAB research note, The return to Office - are we now at the new normal?

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Duration:: 25m
Broadcast on:: 12 Jul 2024
Audio Format:: mp3

So, back to the office with you now. I know it's the weekend and we're all preparing to do the exact opposite, but what about next week? How many days will you be in the office? There's no doubt that the trend that we've seen since the pandemic of staying away has started to reverse, but there's now research suggesting that maybe that trend back into the office has stalled. So have we reached the new normal? And what are the implications of that? That's this week. "The morning call from NAB with Phil Dobby." "The weekend edition." Now, remember when everyone used to go into the office every day, working from home was a rarity and treated, you know, with a large degree of mistrust. Let's be honest, I'm part of the many employers. Will that change with COVID? Of course, flexible working became the thing, but how far has that gone? And are we starting to return back to the office more? Or have we found a happy medium? And also, what are the consequences for employers, for workers, for commercial real estate, the construction companies, the investment trusts, and also all those ancillary businesses that relied on office workers for their income? Well, NAB has been looking into the numbers with morning call regular tapas, Strickland, along with Michael Bush, NAB's head of credit research and credit analyst, Evie Noble. We've got them all on the weekend edition this morning, but let's start with tapas for the magic number tapas by your reckoning as a percentage of pre-COVID numbers. What percentage of time are we now spending in the office in Australia? Do you reckon? It's a great question, and a really hard question to actually answer, and what you have seen in the industry is a lot of surveys, and we all know that surveys tend to be biased, and so to really get a ground up version, we decided to look at some high frequency transit data, and that data indicates that office attendance is probably hovering around 75% of pre-COVID levels, and importantly, on a Monday and Friday, occupancy rates are vastly lower than what occupancy is on a Tuesday to Thursday. It looks like that hybrid working environment has become more entrenched over the past few, particularly in Australia's capital city. When you're saying you're looking at transit data, what sort of footfall in railway stations, that sort of thing? Yeah, so we looked at on the Sydney public transport network, if they use the Opel card, and you couldn't look at Opel card taps of various train stations around Sydney, and so we looked at the train stations in the inner city of Sydney, and for those people who are familiar with Sydney, you'd be familiar with these stations, such as a museum, Martin Place, Town Hall, Central Station, Windyard and St James, and what we found is that they were about 65 to 78% of pre-pandemic, so in terms of the number of taps being done, and what we found really interesting is that's occurring, despite the very immense population growth we have seen over the past couple of years, so I think that's an interesting aspect to it as well, and the other interesting aspect is within the press at least, there's been numerous reports of firms trying to motivate their workers to get back into the office, either using a carrot or a stick approach. What we found in the data is there's been very little shift in that kind of ratio over the past year, so despite those kind of anecdotes, you haven't really seen too much of a shift in terms of the return to office. Now of course that doesn't really tell you about peak day usage, and so we've been looking at pedestrian counts from the pedestrian cameras that say the city of Melbourne and the city of Sydney operate, and what you can see in those cameras is put for traffic falls away quite noticeably on a Monday and on Friday, and effectively they're running at about 70% of the numbers on a Tuesday to Thursday, so if you think capacity's office occupancy is running about say 75%, or 80% on a Tuesday to Thursday, and then you're adding in that Monday and Friday about 70% of that, then you're probably talking about occupancy on a Monday and on a Friday of around 50%. That's why people are saying tumbleweed going through their offices on a Monday morning, isn't it? So EV, what else? So you've been looking at vacancy rates as well, and the supply, so is that changing? Hi Phil, thanks for having me. So looking at office vacancy rates, what we found was that prime office building rates have risen sharply at the early stage of the pandemic, and have remained high, well above pre-COVID levels, for Sydney, Melbourne, and Adelaide CBD's. So we saw Melbourne was hit the hardest, so it's reached a record high vacancy rate for the first quarter of this year, and then with Brisbane, it was a different story. Brisbane rates declined sharply since Q3 2022, and this was because of some government offices moving to better quality spaces. So that's a change. What about the absolute vacancy rates? How does that vary from city to city, which is worse, and how does Australia compare to the rest of the world, for example? So for vacancy rates, Melbourne is the worst, and then that is followed by Adelaide. That's for prime vacancy rates, and then if you look at just broadly how Australia compares to other countries, we looked at the US. So US office attendance has stabilized on average at around 50% of pre-pandemic levels, so we're beating the US, and we're also beating the UK. We saw a Financial Times article reported that average office occupancy, was around 33% in the 12 months to May, and that was roughly half of pre-pandemic levels. So it's interesting. If you've got a theory on that, I mean, I know that for the UK one, it just costs so much to gain to London, so maybe people are avoiding going in if they can, because of cost, and we've got fairly good transport links in Australia, so maybe that's part of it. Yeah, I think that's a various number of reasons why, and one of them is the degree of which people had to transit to get to work, and so in a number of the US, in UK cities, they're quite spread out, especially in London, and so if you've got people commuting and paying, people say that train ticket prices across Australia are relatively high, but say, for example, in Sydney, on the Opal Card Network, you're paying a maximum cap of $50 a week. You compare that to, if you're in a city commuter in London, say coming from Surrey or those kinds of areas, you're paying 200 pounds a week or something like that, in order to... Yeah, more more. Yeah, that's 50 dollars. Yeah, that's 50 dollars for a week would be one day, getting into London. Okay, so the consequences is so much higher there, and there's also some other vagaries that are going on there as well. The lesser systems that the US population got in terms of the pandemic, entrenched a lot more of the pandemic behaviours, I think, than, say, in some places of Australia, and you can kind of see this within Australia itself. So, you look at occupancy in Sydney, and say that's hovering about 84%, according to some surveys, you look at those same surveys for Melbourne, and they're about 75%, and you look at Brisbane, it's about 87%. So, Melbourne, which was one of the most looked down cities in the world, has lower levels of occupancy compared to, say, Sydney and Brisbane. And then when we looked at the pedestrian count data, what we did notice is, it does... Melbourne and Sydney show the same kind of Monday, Friday, to Tuesday, to Thursday, kind of trends. But what we saw in Sydney is there's been no improvement in full traffic between 2023 and 2024, but where there has been a substantial improvement is in Melbourne. So, it just took a lot longer, just given Melbourne seemed to have more entrenched working-from-home behaviours, and maybe that was entrenched because they had a longer period in lockdown and more heavy restrictions there. But now, that has started to normalise more in 2024. So, it could be that London, in some parts of the US, just take a little bit longer in order to get to the same kind of levels that we are seeing, say, in Sydney and in Brisbane. So, this magic 75%, obviously it varies a little bit from city to city, but is that... Do you think that then is that settling down, or are we still on the way to maybe 85 or 90% or even returning back to where we were? And what's to say that number is just this changing behaviour because of Covid? I mean, could it also be that it somehow relates to a downturn that maybe people are working less hours, because there's less work to be done, for example? Yeah, I think, like most of the surveys that you see on the consumer side, people are probably working more hours through the hybrid working, because they're using some of their commute time that they would have used to work. So, it does seem like it's not really the hours component that's driving it. It could be that it's some compensation or implicit compensation for relatively low wages growth through this whole post-pandemic period. And here, I was looking at the real wages data. So, just looking at our wage price index and deflating it by trim-manifation. And when you do that, the actual level of real wages in Australia is sitting at 2011 levels. So, just let that sink in, the level of real wages is going nowhere in Australia over the past 15 years or so. So, that's mainly because inflation has vastly outpaced nominal wages growth. And so, it could be some implicit acknowledgement that that's taking us some kind of compensation that firms are broadly endorsing the hybrid work environment. It's also partly due to the tightness in the labour market and the unemployment rate in Australia at the moment is at 4%. You cast your mind back to pre-pandemic period and the unemployment rate was 5%. So, it's a 1% point gap between where we are now and where we were previously. And sure, the unemployment rate has risen from the pandemic lows of, say, 3.5%. But, the labour market still remains relatively tight compared to where it was prior to the pandemic. So, the balance between workers and employers is a little bit different than it was prior to the pandemic as well. So, yes. So, the workers have got a bit more wriggle room, haven't they? So, if the labour market was less tight, I wonder whether that number would creep back up again. It could be. And then that also brings a whole lot of other topics, like in terms of how do you incentivise workers to get back to the office if that is indeed desirable from an employer perspective. And I think for the vast majority of employers, they wouldn't like their employees to have collaboration time together when they're all in the office together. And whether that has to occur every day of the week or whether, say, three days a week or one day a week, there's some real interesting questions to be asked there. Yeah. But is it hitting productivity, do you think? I mean, it depends who you ask, doesn't it? People will say, as you mentioned, well, I've got those extra hours that I'm working. I know we measure productivity on the output per hour, but as far as the company's concerned, you're probably only working an eight-hour day when in reality, if you have that commute time, you might be working a 10-hour day. So, people at home would say, well, we're working more effectively. Whereas, employers might say, well, no, we feel like our productivity is down. Do we have a sort of an answer to that? No, concrete answer. There's plenty of surveys being done. And what you can say is from an employee perspective, they view themselves on generally more productive at home. And that's because they're adding to it all the household activity that they do. That's not measured in say, output, because it's not done as a marketing exchange rate. So here we're talking about doing the washing and doing cleaning and that kind of stuff. So that's not counted towards national output, but for the individual employee that's adding to productivity during their day, but from an employer perspective, it's not really adding to productivity. And I think one of the uncertainties from an employer perspective is those value-added conversations don't seem to be happening in the same way according to those employer surveys. So it could be one of the reasons why productivity growth is relatively subdued at the moment in most places right around the world. It could be you just not getting enough cross-collaboration amongst teams in that kind of office environment. Well, maybe you also need to look at the correlation between productivity and daytime viewing of Netflix. And if you don't look into those numbers, that might give you some answers. So that's not the case. Not the case. Everyone is working as hard as they possibly can, of course. But Michael, let's bring you in on this. So if we've got people spending 75% of time in the office, what does that mean to the real estate industry? What does it mean to property investment trusts and to property developers as well? Is there going to be less demand? Is there going to be a pressure on rental prices? How's that playing? Yes. Thanks, Phil. Well, certainly we do see pressure on rental yields over the next, certainly one to two years, and quite possibly beyond that time frame as well. Vacancies are already elevated, as you heard E.V. say Melbourne has been hit particularly hard at the moment with elevated vacancies. In fact, vacancies in Melbourne are nearly double their long-term average across the prime office property space at the moment. And then Sydney, they're around half as much again as the long-term average. So they're certainly elevated. The problem that we're seeing at the moment is that there's still quite a large volume of floor space that's currently under construction, but will be reaching completion over the next couple of years. So you're looking in both Melbourne and Sydney, you're looking at around 5% to 60% of current office floor space is going to be increased over the next two years. But is that related to those vacancies? And that short-term, what seems like a short-term oversupply, would that be a way of putting it? Is that because, I mean, it's hard to equate that to the fact that we're working from home more, isn't it? Because we are still going into the office. We're just not there on Mondays and Fridays. That's right. I think it's partly a reflection of the current economic backdrop that we're facing. But I think it's also property like all other sectors does go through cycles. And at the moment, it's being hit by several several factors of which the economic backdrop is one and the flow and effects of COVID is another. So that's likely to weigh on the sector for the next couple of years, at least. So we see it problematic for particularly the prime office sector to absorb all the floor space that's being entering the market in an environment where the economic backdrop isn't exactly providing that much of a tailwind. But that could all change, of course, couldn't it? The economy starts to bounce back. Interest rates come down. Happy days and companies start to grow again, which is a separate factor, isn't it? But do we know where the companies are downsizing because they need less floor space? Or again, they still need that peak floor space, don't they? But I wonder whether they'll try and change their behaviour and try and spread out the days that people are there so that perhaps they can take 25% less space. I think that's right. And ultimately, that's the model that they will try and look at. I think in the immediate term, and it does flow back very much to the rental yield argument at the moment is that some of those tenants won't be able to absorb the inefficient use of the floor space that they're currently facing. And they'll either have to cut back on floor space that's currently led, or they're going to have to try and negotiate rental yields down. So that'll be the short-term measure in the longer term. Still a high degree of uncertainty as to what the response will be. And I'm sure it'll be varied across different industries. So tapas, does that still make commercial property a worthwhile investment there? I mean, if we've got seemingly less demand, if this behaviour doesn't change, or is this really just at the fringes? Because again, we've still got that issue. People still need that peak time space, don't they? Definitely. And I think it's also going to be very dependent on capital cities, as Michael's saying, in terms of new supply coming in. It seems most of that is coming in Sydney and Melbourne over the next couple of years, but not too much elsewhere. So it's going to be capital city dependent in terms of how much supplies coming on. And there's also city-specific factors going on. So for example, in Canberra, the Commonwealth Public Servants have virtually unlimited work from home rights. And so you'd expect vacancy rates and capital rates to be more pressured, say, in a more public Commonwealth public service dominated markets, such as Canberra, than say in the other capital cities. I think it's going to be very capital city dependent as well. But it's just really interesting the net absorption argument there, in terms of the unusualised space. So you look at the Knapp Business Conditions Index, out of the Knapp Business Survey. That's been well above average for the past three years. And yet there has been very little net office space absorption during that period of time. So it does tell you the pandemic experience, the hybrid working that we kind of been transitioning through for the past three years has been impacting on the amount of office space being absorbed by the market. So it does seem to be one of those factors there. Well, we have seen these over the past year. A few sales coming in, in terms of the office market. And what I just wanted to highlight was, say, a five-month in place in Sydney. And that part of that building was sold at a 12% discount from its most recent book value. And from a peak to trough, in terms of the building's peak value, it's at a 24% discount from the very peak valuation of that building going back a couple of years ago. So it does seem like price adjustment is happening in the sector. And that's prompting some buyers to become a little bit more optimistic, or at least cautious optimistic, saying to creep into the sector. And one of the arguments I hear from many of the corporate clients that I speak to is just given how much building costs have risen during the pandemic period. The replacement costs and land costs are exceeding the perceived market value of some of these properties that are in well-located areas, but may just need to be repositioned in terms of the grade. So definitely some people are seeing optimism or cautious optimism building into the sector. And they say sometimes the best time to invest is when everyone else is looking the other way. So I think there are some investors particularly offshore that are looking a little bit more optimistic on this sector. But at the same time, for all the reasons that Michael has been illustrating, the challenges around the office property market is ongoing away in the relatively short period of time. And the other headwind is obviously the interest rate cycle. And now we do think the next move is going to be down for the RBA cash rate. But we recently pushed out our first cash rate cut from November 2024 to May 2025. So in terms of interest rate relief in helping underpin those capital values, that may not occur for quite some time yet. And then when you look at market pricing, markets are pricing about a 50% chance. So the next move the RBA cash rate is actually up and it may be up in say August or November. So it's good to take a while. Yeah, so it's not quite clear whether we're picking the interest rate cycle. And then the other factor you have to look at really is where is the long run mutual rate. So a lot of these office property valuations were done in the post GFC environment when you had cash rates at say 0.5 or 1% and you had QE going on in many places of the world. Our view on the neutral cash rate for Australia is, it's probably hovering about 3.1 to 3.5%. And so our view is the RBA will cut rates and we're penciled in say May next year for that. But we think the trough in that is probably about 3.1%, absent a larger shock. So we're not expecting to go back into that ultra low interest rate environment of the past. So I think that's that's one area. But on the other side of that, obviously population growth remains a very fundamental strength to the office on the market. And that's part of the reason why some are taking a bit more optimism. Right. So yeah, pick your side there. Tap us in the usual economist form. But Evie, if companies are saying, well, okay, we've got this 25% less use of the office by workers, therefore, we want to reduce our space by 25%. I mean, do we know how any examples of how companies are doing that? Yes, it's very interesting topic, Phil. I suppose we don't unfortunately, we don't have the answer. We don't know how organizations will navigate lower office occupancy. But there are a few options. So perhaps companies will either continue to operate inefficiently with four days out of seven unoccupied office offices. And so that's on the one hand. On the other hand, perhaps we'll see them, you know, continue to encourage employees into the office by, you know, carotial stick incentives. So what have we seen happen recently? We've seen businesses offer wellbeing benefits, replace hot desking with a permanent death space, or even linking office attendance to bonuses. And so... Money always talks, doesn't it? Yeah, exactly. And then obviously, you know, free company massage on Fridays and, you know, drinks at the end of the day on Friday, not Thursday. I think someone was saying that some companies are bringing the drinks through to the, you know, at the end of the week on Thursday. Well, let's just encouraging that behavior, isn't it? So tap us very quickly then. The implications on the broader economy. So we don't know what it's doing to productivity. But we know productivity is slow. I wonder if it's part of it. This is part of it where that all depends on how much of the GDP we can put down to work from an office. I'm not sure what that percentage is. But also the implications on, you know, the local economy as well, if people are in the office less. Oh, definitely. And there's some really interesting aspects that spill out of this. If foot traffic through those kind of major metro hubs, especially around train stations, but other transport routes in those kind of inner city areas is peaking on a Tuesday, Wednesday, Thursday, then the businesses servicing those who are used to, say, everyday being relatively busy, then they have to adjust their operating model. So I think some of the inflation we have seen, particularly in the quick service food retail has been trying to recoup some of the loss turnover that is occurring on, say, on a Monday and on a Friday when there's less people in the office, say 50%, and then averaging that out through the week. So it could be some of the inflation we have seen in that area is to compensate for some of the loss revenue on the other days of the week, but also has other implications. So for shopping street, retail, cafes, restaurants, in the kind of suburban areas that have been well supported during the pandemic period with workers working from home and maybe getting a coffee and all those kind of things and doing their chores and stuff around home during the week, to the extent that firms are successful in motivating their employees to come back to the office either on a Tuesday, Wednesday, Thursday, or a more frequent basis than it has spillover effects for those local economies as well. Well, yeah, I think it is set here, isn't it? I sense that where we are now is where we're going to be for quite a long time. But the people have adopted to this new model, and that's the new normal. Well, I think so. And until we see a more substantial working in the labor market, I think that's the way it's going to play out. It could be, though, if the economy does, we can further, and if the unemployment rate does rise a little bit higher than that, balance starts to shift a little bit more in terms of the workers in terms of the employers' favor. And so that could start to shift that hybrid working environment. But for the foreseeable future, it does seem to be that hybrid working is becoming more entrenched. And that Monday and Friday, there is vastly less attendance in the office than compared to on a Tuesday, Wednesday, Wednesday, Wednesday, Wednesday, let's see what's like at the other side of the next recession. But that could be a long way away, couldn't it, knowing Australia's history? Good to talk to you, Taffes. Thanks, Michael, as well, and thanks, Sevi. Well, it's good to have you both on the morning call for the first time. Thank you. Thank you. And that research that we're referring to published for NAB customers only, it's called the return to office. Are we now at the new normal? So get hold of a copy of that, and you might have well have it in your inbox. Now, that's it for today. I am back on Monday morning with another edition of the morning call with guess who? Yes, tap our Strickland. We can't go into him. So I'll be back for that. So will he enjoy your weekend? I hope I will. If you're an English soccer fan, it could go either way, couldn't it? See you Monday morning. Thanks for listening. The weekend edition.