The hybrid working model weighs on office space vacancy levels

The commercial real estate sector is making a comeback amid the ongoing business normalcy.

An indicator of that is improved absorption of office spaces. Absorption at 62 million square feet (msf) hit a record in FY22, Kotak Institutional Equities said in a report on 7 June. Even so, vacancy levels remained elevated at 15% in FY22. Increased supply of new office spaces is one of the reasons for this. In FY22, new supply rose to 38smsf from 32msf in FY21, said the Kotak report.

“Demand and supply for office properties continues to improve; however, with scale of supply higher than demand in recent past, vacancy level in office spaces is still high at around 17% at an all-India level in June,” said Vivek Rathi, director-research, Knight Frank India. Rathi also pointed out that the earlier phenomena of pre-commitment agreements which happened when occupiers had complete clarity on hiring plans is relatively lower now than the pre-pandemic period.

The IT sector is a key contributor to demand for Grade-A office properties. In the backdrop of strong deal win pipeline and robust demand commentary, IT companies continue to be on a hiring spree. Even so, industry experts say, vacancy levels may see a gradual decline, at best.

“Vacancy levels won’t ease off in a hurry because the hybrid working model won’t go away completely given cost saving advantages,” said Abhishek Lodhiya, lead analyst at Yes Securities Ltd. Further, the demand for co-working space is catching up, so companies having exposure to smaller cities may adopt a hub-and-spoke model.

“They may operate from Grade-A offices in select regions and opt for co-working spaces in tier-II cities. While renewal of prior office lease agreements is happening, the pre-covid confidence is missing,” he said.

Simply put, the revival in demand is yet to see a sharp uptick to translate into lower vacancy for office space. A crucial development that investors need to watch out for is the re-emergence of covid caseloads, especially in the key state of Maharashtra. Covid-led restrictions could hurt physical occupancies in office and derail recovery.

So, Rathi expects vacancy levels to come down marginally by 10-30 basis points in the near term. One basis point is 0.01%. “A meaningful decline in vacancy levels as seen in boom years of 2017 and 2019, would require robust demand, which will gradually build as physical occupancy too reaches closer to 90-100%,” he said.

Meanwhile, analysts note, office rentals are improving in key markets such as Bengaluru and Pune, compared to the year-ago period. However, they are yet to see a significant improvement. Also, if the covid-related risk plays out, then renewals might get delays, hurting rental outlook.