CRE Sentiment Index: (Y)OUR SPACE Conversations

Dr Lee Elliott, Global Head of Occupier Research at Knight Frank chats with Craig Van Pelt, Cresa’s Head of Research, comparing the regional results of the Corporate Real Estate Sentiment Index between North America, Europe and Asia-Pacific.  Across the regions, there is growing positivity around the global economic outlook and corporate revenue growth. However, caution prevails around strategic plans to raise headcount for most companies, with many choosing to focus instead on boosting the efficiency and productivity of their current workforces for the next 6 months.

Watch the full conversation here: 

Transcript

Lee Elliott

Hi,  I’m Lee Elliott, Global Head of Occupier Research at Knight Frank and I am delighted to be joined by Craig Van Pelt my equivalent in our North American partner, Cresa.  How are you doing, Craig? 

Craig Van Pelt

Good, Lee. It’s good to see you. I’m the head of research here at Cresa and we're excited to talk a little bit about the sentiment index. 

Lee Elliott

Yeah, great. So, the purpose of today's conversation is to think a little bit about the occupier mindset. That’s something that has been an area of fascination and exploration for both Craig and I for a number of years now in our respective roles and our wider careers.  I suppose the sort of basis of this conversation is our “Your Space” Research, which we conducted last year, tended to take a sort of three-year out view of where occupiers were aiming to get in the post pandemic world with their real estate at the both portfolio and the workplace level. And that's great. You know, everybody's got ambition to get to an end and destination in a time period, but we all know that particularly in this world that we live in currently that things aren't always in a straight line and there's always challenges to sentiment to the ability to actually get to that end destination. It's never a straightforward path, it's always twisting and turning. One of the things that we decided to do as a house back in the first quarter of 2022, was really start to understand that short term dynamic alongside those medium-term outlooks and give a sense of where sentiment is at any moment in time. So, we've since the first quarter of 2022 conducted a corporate real estate sentiment index and industry first where in our respective regions, we're canvassing the views are about 100 corporate real estate leaders every quarter or every six months and, and trying to get a sense of where the mindset is at. And that's what Craig and I are gonna speak about today. 

Craig, what's your overarching sort of impression of where the occupier mindset is at in North America at this moment in time? 

Craig Van Pelt

Yeah, I think, I think it is still reactionary to the events of the pandemic. You know, it's, it's a little bit of a mix because we are still waiting for the other shoe to drop in terms of the economy, yet we're still creating jobs. There is still some positive sentiment out there. But,  it's still cautionary. People are still waiting for the smoke to clear to make, to make long term strategic decisions because real estate is a long-term strategic decision and the headcount drives that demand. I think people in companies and leaders in organizations are still waiting to kind of see where everything shakes out. 

Lee Elliott

Yeah. And that's really interesting because there's a number of things that immediately we can pick up on there. But I think, my view of the overall sentiment in the Asia PAC and EMEA regions is similar. 

You know, we've got occupiers that are recognizing things are perhaps not as grave as perhaps were anticipated at the start of 2023, when global recession was very much the sort of watchword, everybody was concerned about how long and how deep that global recession might be, and we kind of averted that.  But it hasn't really been back into a growth mindset that's really driven occupier sentiment positive. If you if you look at occupier sentiment from Asian and European respondents, we've still got a pretty neutral mindset. We're not really super positive, we're not really super negative and we've been bumbling along at that rate for probably the last five or six quarters. There's obviously quarter on quarter, quarter movement, but generally the mindset has been moderate. Cautionary as you say, and perhaps a little bit fragile as well. My sense is that corporate sentiment is there to be pushed around a little bit by macro events and we've got a few of those upcoming, not least in the in the political sphere in both parts of the world going forward, something we might come back to. 

If we look at the sentiment indexes, we've constructed we've got the overall picture of the sentiment. The sentiment index breaks down into three subcomponents looking at three different dynamics, that growth dynamic, the portfolio dynamic and then the workplace dynamic. I wanted to just sort of explore that with you a little bit Craig, if I may. 

You've already touched upon the economy still generating jobs and in a more positive state than perhaps we may have anticipated. It's interesting when you look at the growth dynamic in the sentiment index. You know, there is a growing positivity about the global economic outlook. Quarter on quarter inch nudging up. How do you see that playing course over the course of the rest of the year? 

Craig Van Pelt

Well, it's really interesting. Like I said, unemployment here is near, still near record lows. We are still adding jobs. But if you scratch the surface on that, what are the jobs that we're adding?  And a lot of them are in service related roles and in healthcare.  The knowledge worker office, typically office occupying jobs have certainly slowed in the last year, maybe not retracted, but I would say they're at below even pre-pandemic growth levels. So, I think because of that demand is a little bit curved even more than it would be due to other issues surrounding return to office and occupancy levels in general. So, I think hiring is not something that a lot of companies are really thinking about right now. I think it's efficiently and effectively using your workforce and deciding maybe we're gonna wait a little bit and see what happens before we think about headcount and that’s kind of what the sentiment survey said. Headcount doesn’t look -- a lot of companies are not looking to raise headcount in the next six months, although they are generally optimistic about the economy. So, there’s a bit of a paradox. 

Lee Elliott

Yeah, and that’s something we’ve absolutely seen in the European Asain markets too. What we’ve seen is relatively moderate statement about future headcount growth, but actually very positive sentiment about revenue growth for the corporate level. And that would point to, you know, as you alluded to more efficiency, more focus on productivity. We’re hearing a lot more now from occupiers as they've come out of the defensive occupier mindset that we had during the pandemic, which was all about survival. We're now seeing much more discussion about using transformative technology, particularly AI, to drive efficiency, to drive productivity without adding to headcount and of course that will ultimately shape real estate portfolios. I don't think we're there yet, but certainly that reshaping of portfolios, rightsizing portfolios if you like, is probably likely to occur.  And one of the reasons I think we're not there yet is firstly that technology is still being rolled out and applied and people are trying to figure out the the impacts it might have on their corporate structures and what the jobs that people do if you like. 

But I think the other one that's very clear in our sentiment index, and I’d be interested in what you're seeing on the other side of the pond, is capital expenditure constraints. A really interesting sort of end of Q4 2023 when suddenly all the respondents in Asia and EMEA sort of pointed to a much more expansive use of capital and capital expenditure to drive growth and support real estate activity. And then that suddenly just sort of disappeared in the first two quarters of this year. As we've seen occupiers, I think, probably protecting balance sheets a little bit and putting the brakes on capital expenditure. That of course has huge implications for real estate activity, whether it's relocations or whether it's sort of investing heavily in sort of workplaces. Does that chime with what you're seeing? 

Craig Van Pelt

Yeah, it really does. And I think if we look a little bit closer, you saw, you did see more favorable sentiment a year ago around capital expenditures, you know? And I think you could argue certainly that companies shot their shot, right? They spent some of that money last year to help increase efficiencies and make amenities more available to employees and be fine. If I’m being honest, it’s probably a little bit of hey, we do spend all this money and our occupancy levels haven’t really changed in a meaningful way. So, is that worth spending, you know, that kind of money within the office space, to improve it? And I think maybe you’re seeing a little bit of that sentiment saying, “Alright, well, we spent the money, let’s see how and if this works before we spend more money”. 

Lee Elliott

Right, yeah and definitely the breaks on capital expenditure are impacting fit out, impacting relocation and as you say, I think having spent a lot, invested a lot of time in driving a more positive workplace experience through investing in the workplaces that many organizations presently have. I almost sense that corporate real estate leaders have kind of got to the end of their tether a little bit with that particular dynamic. And you know, we're now in the world of mandating returns to office and all the emotion and discussion that that brings. 
If you sort of look at the sentiment, as we've said already a couple of times, it's very much about driving efficiency. And driving resilience I suppose in a, in a post pandemic world, one of the things that we're seeing from Asian and European respondents to the survey is offshoring coming back up on the radar. In fact, if you look at our quarterly observations of sentiment, we've seen 3/4 of the increased positive sentiment around offshoring. There's no doubt that occupiers in both of those geographies from Europe and Asia are thinking more about relocating what may have traditionally been called back or middle office functions, but actually now are much more advanced than digital platform and all kinds of sort of technology driven business functions, what's the sort of the the dynamic in on your side of the water?

Craig Van Pelt

It’s a little backwards I think generally speaking, only because, and I’m not going to get into supply chains and disruptions over COVID, because I think that was one thing that really impacted decision making in terms of where to locate your back office, kind of things from an office perspective. And I think we’ve seen a lot more companies think of doing more on shoring, or even near shoring, if you will, just because it removed some of the complexities involved. And it’s already very, very complex. And if you can remove some of those, I think it behooves organizations to think that way. And I think we’ve seen a bit of that protectionist, nationalistic view in the United States and North America in the last couple of years. 

Lee Elliott

Now it’s interesting you mentioned complexity because, managing complexity and that's exactly what's going on. I I think you raised a really interesting point. There is a distinction here clearly between office functionality and that being offshore versus production distribution type functionality, which is definitely being pushed along by a wave of measuring. Or reassuring, whether that's adding right politics or otherwise. We'll leave for another time, but. You know, I think that dynamic is really interesting and we've certainly seen in in the context of the Asian markets and to the green Europe. Malaysia, India. Central Eastern Europe sort of coming up on the radar now increasingly, not necessarily people put in functions there right now, but certainly thinking about that more as an efficiency play, as a labor arbitrage, but also as an ability to access talent that perhaps might not be in the sorts of volumes. That we would like in more established markets or, or or where that talent is being released. 

Craig Van Pelt

One thing I might add about North America that’ve I’ve seen – we had a really big movement in the 2000s, early 2010s about back to the city, back from the suburbs, back to the urban environments, because that is where the talent was. But I think what we’ve seen the last couple of years in suburban office spaces have become kind of winners, because they’re closer to a lot of workers. They’re easy to get to. It’s a US problem or not a problem, but lots of parking right for people out in the suburbs, and because of availabilities, it’s becoming much more reasonable to lease space in the suburbs, as opposed to the city center. And I think that is at least regionally in the United States, that has become a movement or a trend that we certainly see in the past couple of years. 

Lee Elliott

Yeah I think that's a really interesting contrast. We don’t I don’t personally see that in Europe and Asia that in Europe and they used anywhere near the same extent that there may be lots of cultural reasons for that, but certainly our gravitational poise towards CBD markets, undoubtedly business parks a little more challenge despite some of the benefits they bring around parking and the like. What we've got, I think at the moment is a very clear contrast between. That long term ambition that I mentioned at the beginning and the short-term ability to act. And I think what that's playing out in real estate behavior at the moment is if there are near term lease events, expires, breaks, particularly expires, we've generally seen occupiers renewing or regearing. Either because there's an absence of quality stock. to take in the market particularly CBD markets or because they just had don't have the conviction right now because they don't have sufficient signals around the direction of travel on occupancy for example. What's your what's your sense of that sort of dynamic in the US we've seen a lot more renewal? 

Craig Van Pelt

Generally speaking, yes, I think it’s a little bit, we’d say over here, kicking the can down the road a little bit until it becomes a little bit clearer. But overall, you know, we’re not through all of those pre-Covid leases rolling. You know, we had this discussion internally the other day – we're probably 60 – 70% through those leased that were signed pre-pandemic. And those continue to roll, I think we will certainly see more renewals. Or what we’ve also seen is just rightsizing, taking less space and more well amenitized flight to quality, which is the thing. I’m sure you’ve seen it all over the world as well. If you’re not going to spend the same amount of money on a larger footprint, maybe you’ll reinvest some of that capital in a smaller space in a better well amenitized location. 

Lee Elliott

Yeah and I mean I’m glad you mentioned flight to quality. Podcasts and reports these days, it'd be remiss of us not to talk about it a little bit. One of the things I've been trying to talk to audiences about when we present presented your space to them is what do we actually mean by flight to quality? And I break it down into, I'm sure there are other dynamics one point to, but I break it down into sort of three distinct flights or flight to more flexible space. Whether that is coworking space and interesting, the observations from European market are that we are seeing more corporate occupiers taking Co working managed service spaces and ever before. And and even if it's conventional, space releases tend to have a lot more flexibility in short term. There's a flight to flex. There's a flight to sustainable real estate, IE. Spaces that have accreditations or certifications and then a flight, as you mentioned, to amenity rich space to support that return to office and create a more compelling environment and experience for their occupants. It seems to me and looking at the data that we have and I've seen side of your data, the flight sustainability piece in the US is probably not as foremost in the occupier mindset as it might be in in Europe and Asia. Would that be fair?

Craig Van Pelt

Yeah I think that’s fair. I think generally, the United States is trailing the rest of the world in terms of how much – importance is the wrong word, because sustainability is incredibly important to any organization that wants to do business in the world, not just because of that, but it’s the right thing to do. So, I think, you know, to read the question, it says, you have to remember it's in the next six months. So maybe it is, we have a fairly neutral to negative kind of response from the survey about how much you know, how much weight are you putting into sustainability? I know it’s important to organizations, but I think at this point they’re also thinking about, Hey, what can we do? And what do we need to do to do it right size our space and then we will that is part of it. The long term solution, certainly but in the short term, I think it’s maybe not given as much weight as it is some other parts of the world. 

Lee Elliott

And I think that's a really important point to make. We're gauging sentiment around some very narrow elements and if you take something like sustainability it is obviously much, much bigger than taking a building that's got a certification, which is a bit we're kind of exploring. And I think there's a lot of, you know, operation type activity that companies can and are driving around ESG, which broadens that discussion that debate so.

We, we're certainly seeing, we're talking about constraints earlier capital expenditure being one of the constraints we've seen in Europe and Asia to an extent is the lack of certified buildings that actually enable that move towards green buildings, more sustainable buildings. And I think that's even if, even if capital expenditure starts to improve, I still think that's going to be a break on the extent to where occupiers can really move.

I know Cresa has recently moved to a a new shiny HQ in in Chicago and looking forward to getting there at some point and not least becuase it's got a basketball court, although my basketball is not great but you know it's there to be improved, and you've clearly grappled with that sort of dynamic of taking more amenitized space as an organization that's consistent with what you're seeing across the occupier base? 

Craig Van Pelt 

It is. It’s an investment in your people, right? And I think it’s an investment in the time and energy they spend in the office with each other, and it’s important that they are comfortable and happy right, where they’re working, and we actually started that project a couple years back and it turned out really well and we’ve had pretty good return back to the office in Chicago. And I have to believe that part of that is because we have such a wonderful place to be. Yeah it certainly helps with that. It’s true that amenitized space has a lot of value and it increases the experience. Time will tell how much of that, you know, what the return on investment will be, if you can measure it in some way. But I certainly think it is, in some ways table stakes, what you might say for, you know getting employees to enagage and come back into the office on a more regular basis. 

Lee Elliott 

Yeah, and maybe that's a good point in which to close out the conversation. When we look at amenities, one of the things that I sort of grapple with a little bit is that we have seen this push to amenity rich buildings, but we're now getting to a point where the very best in class buildings in and around Europe and Asia are pretty heavily amenitized. And it's hard to investigate or explore or understand what's next in terms of that roster of amenity. I mean, I've said for a number of years now that I think educational amenity, town hall spaces, nature spaces and educational programs are going to be really critical in a in a world that's upskilling and reskilling. But I actually think we might have started to hit a bit of a ceiling in amenity. Not, not with notwithstanding the point we've already made about capital expenditure. And I think the bigger issue for driving the occupational markets is going to be actually how you bring some of those inferior buildings that are going to be around because the embedded carbon and the fact that they need to be part of our built environment going forward. How do you bring them up to to standard? And I almost see that sort of starting to shift bit before a certain sat here in London. It's definitely a discussion that we see in the London market all the time. What's your sort of take away for the next six months break in terms of the North American occupational market dynamic?

Craig Van Pelt 

I think for the next six months it will be pretty stable from where we are right now. I dont think there’s going to be a lot of change, and there’s several reasons for that, including, this is an election year in the United States and companies usually, I don’t want to say see it as an easy excuse, but typically there’s a lot of waiting to see what happens in an election in terms of the decisions they might make moving forward. So I dont see any big events. I dont believe we’re going to get into a recession this year. But I also think we’re not going to see a lot of big GDP growth. I think it’s going to be a little bit boring, which is good. We can use boring. 

Lee Elliott

Well after these couple of years we’ve had, we could definitely do with boring. 

Craig Van Pelt 

Yeah, I think it’s going to be a pretty stable year in terms of the occupational occupier viewpoint of things. Until we know a little bit more and some more of these leases begin to roll. Because I think that again I think we’re not going to have a real picture of where we are or where the bottom is or if we’ve reached the bottom of the corporate you know the commercial real estate market on the office side maybe for another 24-36 months and then we’ll look back and understand a little bit better but we’re still really in the middle of it. 

Lee Elliot 

Yeah, I think the politcal point in an interesting one. We won't get into the actual shades of those debates, but you know, 80% of the world's population facing up to some sort of democratic position over the course of this year. That's gotta be a little bit of a break on on corporate behaviour that want to see how that plays out. So I agree with you. I think this year is probably a year where a little bit more sedate where we do start to get some more signals from the way that people are returning to the office and what that means for long term occupancy and thereafter, I think we start to get some some real behaviour and behavioral changes around sort of mixing up the portfolio, right sizing, changing the corporate map, all those exciting things that we can't wait to get stuck into.

Craig, thanks very much for joining me. It's always a delight to talk to you and get your perspective from the American market, and I hope that we can do that again in the near future.

Craig Van Pelt

Always a pleasure Lee. Good seeing you.