It was 2005 in Scranton, Pennsylvania. The fictional company Dunder Mifflin from the TV show “The Office” occupies a dilapidated building, where a group of employees in beige suits move paper in the digital world.
Fast forward 20 years and there are 110 million square feet of vacant office space across the UK. Meanwhile, a call center worker answered calls in an empty room at home while walking on a treadmill under her desk.
A September survey by Forbes showed that as many as 64% of employees were working from home in some form.
Will the business loan market help or hinder?
Not surprisingly, many businesses are looking to reduce their footprint as leases expire. After all, corporate real estate is the second largest expense after payroll.
Offices are the only sector in the market to post negative year-over-year returns. So, is the asset class on its way out? Or, just as Dunder Mifflin pivoted to printer production, will the industry adapt and overcome the drop in demand? More importantly, will the business loan market help or hinder?
Floor space in the UK has fallen by 23% since 2019, with the full impact still to be seen once the lease expiry cycle is over. This paints a bleak picture, but demand in central London is seeing positive returns and it seems to me that where the City of London is leading, we are not far behind.
Commercial bank managers in the era of artificial intelligence still insist on paper applications
Savvy business owners are purchasing office space for their own use and for rent. This is great for cash flow and affordability, while also future-proofing their growth agenda. However, commercial banks do not consider supplementary rental income when calculating affordability, which undermines ingenuity and discourages investment.
Quality above all else
In order to attract employees back, companies place great emphasis on quality office space. “New” measures such as shared office spaces and shower facilities have been replaced by the need for more modern facilities and wellness attributes. As a result, rents for prime inventory have increased despite a decline in square footage.
The gap between prime space and B-grade properties is widening, resulting in more abandoned inventory being repurposed into residential and other asset classes. This is partly positive given the housing shortage, but if offices make a bigger comeback than expected, what does that mean for the business market?
Lenders need to create an environment conducive to the growth of SMEs
Flexibility in lease terms is required as tenants seek greater freedom to upsize or downsize. This creates a dilemma for business investors. They are finding it harder to fill vacancies as nimble SMEs don’t want to risk committing to long-term leases, while lenders won’t consider loans where tenants hold short-term licenses.
The disconnect between market demand and lending standards will inhibit investment in the sector and exacerbate vacancy challenges.
Evolving legislation means energy efficiency in office buildings is high on the agenda. The EPC product ultimately provides meaningful incentives for investment in efficiency improvements, with discounts of up to 0.8% available for Class A to C commercial real estate.
Savvy business owners are buying office space to own and rent
Despite some positive initiatives, lenders still need to create an environment conducive to SME growth, and they are falling short in three key areas.
First, excessive dynamic pricing by commercial lenders deprives customers of all transparency and certainty. Affordability and restrictive stress tests mean deals are often hinged on razor-thin margins, so it’s impossible to do business with radically different options when customers are locked in.
Second, businesses accepted bounce-back loans and coronavirus business interruption loan schemes with good intentions to survive the global pandemic, without realizing that this would make future borrowing more difficult. Despite the fixed payment terms, lenders are subjecting these loans to a 200% stress test. This prevents businesses from accessing capital to rebound and grow.
Third, bottlenecks in the valuation phase hinder the entire process. Most valuation information is market based, so there is no reason to take 21 days to appraise a property. Surveyors need to innovate.
Central London is seeing positive returns on demand and, in my view, where the City of London leads the way, we are not far behind
After four difficult years, there is positivity in the air. Interest rates are falling, lenders’ appetite is back, and customers are shaking off the inertia that plagues business investing. The pro-construction government is championing planning reforms, so now is the time to support SMEs, the backbone of the economy.
The office environment has adapted well to the new normal, but its long-term success requires investment and innovation. Twenty years since Dunder Mifflin abandoned its paper business, commercial bank managers in the artificial intelligence era still insist on using paper applications.
It’s time to step up.
Peter Williams is CEO of Propp.io
This article appeared in the November 2024 edition Mortgage strategy.
If you would like to subscribe to the monthly print or digital magazine, please click here.
