It’s 2005 in Scranton, Pennsylvania. Dunder Mifflin, the fictional business in TV show The Office, occupies a tired building where a beige-suited group of employees flogs paper in a world that’s gone digital.
Fast-forward 20 years and 110 million square feet of office space sits empty across Britain. Meanwhile, a call-centre worker takes calls from their spare room at home while marching on an under-desk treadmill.
As many as 64% of employees surveyed by Forbes in September work from home in some capacity.
Will the commercial lending market help, or hinder?
Unsurprisingly, then, as leases expire, many businesses expect to decrease their footprint. Corporate real estate is the second-largest expense after salary, after all.
Offices are the only sector in the market showing year-on-year negative returns. So, is the asset class on the way out? Or, just as Dunder Mifflin pivoted to printer production, will the sector adapt and overcome sinking demand? And, more importantly, will the commercial lending market help, or hinder?
Square footage take-up in the UK is down 23% since 2019 and the full impact remains to be seen when the cycle of lease expiries has concluded. This paints a gloomy picture, but a positive return in demand is occurring in central London and, in my view, where the City leads, we follow.
Commercial bank managers in the age of AI still cling to paper applications
Savvy business owners are buying office space to both occupy and rent out. This is great for cashflow and affordability while future-proofing their growth agenda. However, high-street lenders won’t consider supplementary rental income when calculating affordability, which penalises ingenuity and prevents investment.
Quality over everything
To attract workers back, businesses are placing a premium on prime office space. ‘New’ initiatives, such as co-working spaces and shower facilities, have been superseded by demand for more modern amenities and wellness attributes. So, although square footage is down, rents for quality stock are up.
The gap between prime space and Grade B property is widening, leading to more repurposing of obsolete stock into residential and other asset classes. Given the housing shortage, this is positive to some degree, but what will this mean to the commercial market if the return to the office is more substantial than predicted?
Lenders need to curate an environment that makes growth accessible to SMEs
Lease-term flexibility is in demand as occupiers seek greater freedom to scale up or scale down. This leaves commercial investors stuck between a rock and a hard place. They’re finding it harder to fill their vacancies because nimble SMEs don’t want to risk committing to a long lease, while lenders won’t consider a loan that has tenants on short-term licences.
This disconnect between market demand and lending criteria will stifle investment in the sector and compound vacancy challenges.
Evolving legislation has meant energy efficiency in office buildings is high on the agenda. EPC products are finally offering a meaningful incentive to invest in efficiency improvements, with discounts of up to 0.8% on commercial properties with a rating of A to C.
Savvy business owners are buying office space to both occupy and rent out
Despite some positive movements, lenders need to curate an environment that makes growth accessible to SMEs, and they are lacking in three key areas.
First, excessive dynamic pricing from commercial lenders strips away all transparency and certainty for clients. Affordability and restrictive stress testing mean deals often hinge on paper-thin margins, so presenting options that will differ greatly by the time the client can lock in is no way to do business.
Second, bounceback loans and the Coronavirus Business Interruption Loan Scheme were taken up by businesses in good faith to survive a global pandemic, unaware that it would make future borrowing more difficult. Lenders are stress-testing these loans at 200% despite fixed payment terms. This is preventing business accessing the money to both bounce back and grow.
Third, bottlenecking at the valuation stage is holding up the whole process. Most of the valuation information is market based, so there’s no reason for it to take 21 days to assess a property. Surveyors need to innovate.
A positive return in demand is occurring in central London and, in my view, where the City leads, we follow
There are whistles of positivity in the air after four tough years. Rates are on their way down, lender appetite is back and clients have escaped the inertia that has plagued business investment. A pro-build government is championing planning reform, so now is the time to champion SMEs, the backbone of the economy.
The office landscape has adapted well to the new normal, but its long-term success requires investment and innovation. Two decades since Dunder Mifflin binned its paper operations, commercial bank managers in the age of AI still cling to paper applications.
It’s time to rise to the occasion.
Peter Williams is chief executive of Propp.io
This article featured in the November 2024 edition of Mortgage Strategy.
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