Investing in strata offices in a post-pandemic world

By Leonard Tay,
Knight Frank Singapore
/ EdgeProp Singapore |
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SINGAPORE (EDGEPROP) - While residential property transactions remained healthy amid the Covid pandemic, commercial properties were subjected to contractionary pressures, with office rents and prices declining throughout the whole of last year. (See: Two freehold commercial buildings on South Bridge Road going for $45 mil)
However, in early 2021, office rental declines began to ease. Even though Prime Grade office rents in the Raffles Place/Marina Bay precinct continued to decline in the first quarter of 2021, falling moderately by 1.0% q-o-q to $10.06 psf per month, this was not as severe as the quarterly declines of 4.1%, 2.3% and 2.0% for 2Q2020, 3Q2020 and 4Q2020 respectively.
With occupancy rate of prime office space at 94.2% in 1Q2021, this put a halt on the downward slide in rents. The URA office rental index in the Central Region turned positive for the first time since 2Q2019. In fact, it showed a 3.3% q-o-q growth in 1Q2021 — the largest quarterly growth since 1Q2011, and a reversal from the 3.5% quarterly decline recorded in 4Q2020.
How has strata-titled office buildings weathered the pandemic compared to those owned by single owners? Strata-titled office buildings are built by developers who would subdivide the usable space in the building into individual office units. These units are then sold to users or investors, much like strata-titled condominium units. Likewise, the owners contribute to the maintenance of the common areas in the building based on their share value and strata area.
For strata commercial offices, the “circuit breaker” (from April 7 to June 1, 2020), as well as the economic recession that followed, did much more to the asset sub-class than just lower its volume of transactions and prices. The office market began to change and morph as remote working was forcefully applied to Singapore’s workforce, breaking through the cultural resistance frowned upon by many traditionally minded leaders of industry.
As the world grapples with the complexities of a post-pandemic world, the permanent and widespread practice of working from home (WFH) will have the inevitable consequence of lowering the net new demand for strata office spaces. Nevertheless, such contractionary pressures are likely to be offset by global tech giants and MNCs that continue to make big bets, setting up shop in Singapore.

With WFH, is there still a need for office spaces?

While it is true that some businesses will continue to tighten their costs associated with large overheads such as office leases, this does not mean the office will become obsolete.
For businesses, the workplace remains relevant post-pandemic due to the innate need for people to meet and interact. Tone of voice, facial expressions and context can get lost in virtual translation when teams are not communicating side-by-side.
A physical office also offers support in the form of environment and equipment. At home, remote workstations are likely to be dining tables surrounded by demanding families, unsupportive chairs and temperamental Internet connections that struggle to uphold software that employees rely heavily on to communicate. Dining tables and couches are not designed to inspire productivity, credibility and staff retention. But many offices are.
So what is so different about the strata office compared to other commercial real estate that might benefit an investor in a post-pandemic world?

Predictable mortgage payments

One of the key traditional advantages of owning strata office space is a hedge against volatility typified in office rent cycles. Mortgage payments are more predictable on cash flows than rental renewals, especially during periods when demand exceeds supply. In an age of remote working and flexible space use, strata office owners can adopt nimble/agile space strategies, free from the vagaries of market rental cycles.

Greater control of asset utility

Right off the bat, owners of strata office have the flexibility to choose whether they would prefer to be landlords or occupiers as the economic climate changes from one cycle to the next. Unlike residential investment properties, strata offices as commercial properties do not incur additional buyer’s stamp duty.
Small enterprises and family businesses are able to better manage the control over their business space. With flexible work arrangements, unutilised space can be sub-let for supplementary income during periods of economic downturn and taken back during periods of organic company growth.
As an investment vehicle, a strata office unit or even a combination of units is relatively more affordable than an entire building. Therefore, investment opportunities are open to smaller investors with more modest appetites.
When the above factors are taken as a whole, and enjoined with the agility of remote working, the strata office market might yet see a new lease of activity by providing the right mix of control, flexibility, potential for capital gain and security for several different types of SMEs and investors.
An estimated 16.6% of the total office spaces available in Singapore are strata-titled, which works out to about 14.6 million sq ft.More than 55% of the strata office inventory is in the CBD (Photo: Albert Chua/EdgeProp Singapore)

Where are strata offices usually located?

An estimated 16.6% of the total office spaces available in Singapore are strata-titled, which works out to about 14.6 million sq ft. More than 55% of the strata office inventory is in the CBD, comprising the Downtown Core and Orchard Planning Areas. They vary in terms of location, age and quality.
Since 2015, annual transaction volume of strata offices has totalled less than 400 units. This was also because there was not a regular supply of new strata office projects launched compared to the 2011 to 2013 period. The already thin transaction volume was made worse by the Covid-19 outbreak that affected all aspects of the economy in 2020.
Nevertheless, while transaction activity fell due to the prevailing pessimistic and cautious environment, average unit prices declined by a fairly moderate 3.2% in 2020 to about $2,093 psf on strata area, from $2,162 psf in 2019. In 1Q2021, average unit prices dropped by a marginal 2.5% from 2020 to $2,041 psf.
The approach for investing in strata offices, like all commercial property, is to focus on long-term rental returns.
Not everyone has the wherewithal to buy an entire office building. But for smaller enterprises, family proprietorships, local businesses and entrepreneurial start-ups, as well as individual retail investors looking to gain a foothold in the office market that forms Singapore’s commercial hub, strata offices can provide that niche.

Looking for a strata commercial office to invest?

Typical locations which potential business occupiers tend to favour are in the CBD and city-fringe areas. Even with companies opting for flexible rents and agile WFH arrangements, there remains demand for decent-sized office units that can provide companies with the ability to house 10 to 30 employees. Anyone interested in strata office space should also look out for buildings that are well managed, perhaps recently refurbished and within walking distance to MRT stations, as buildings with such attributes tend to retain their value longer with greater potential for lease.

Pros and cons

Strata offices might provide a unique opportunity when one considers occupier space requirements, investment potential, and the need to right-size in a technology-enabled, post-Covid-19 world.
Nevertheless, any investor should also be aware that multiple ownership within an office building can result in a wide range of occupiers. The standards of upkeep run by a Management Corporation (MCST) can sometimes be inconsistent.
Rental levels of strata office buildings could therefore come under further contractionary pressure when factors such as age and quality of maintenance are taken into consideration, relative to a fully owned modern office tower.
The supply of new strata office space has been limited in recent years. Hence there are more ageing strata office stock in the market, with less competitive rents.
However, office rents are expected to bottom out in 2021 before recovering in 2022. It may be an opportune time to invest in an office space as values are relatively stable now, with perhaps some discount when compared to little over a year ago before the virus outbreak.
Leonard Tay is the head of research at Knight Frank Singapore

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