Head of Real Estate Analysis, Credit Suisse
Table of contents
The sharp acceleration of change in the work world caused by the COVID-19 pandemic is putting pressure on the office real estate market. Working from home and desk-sharing concepts reduce the need for square meters of office space per employee. Although this trend is even overcompensated in the long term by employment growth, digitalization, and tertiarization, Credit Suisse continues to expect a one-time reduction in office space requirements of about 15% by around 2026 due to persistently reduced office presence in many companies.
Demand on the Swiss office space market is temporarily at an interim high. This is due to catch-up effects from the COVID-19 pandemic as well as strong employment growth. For 2022, the additional requirement is expected to amount to 840,000 m² – in 2023, however, it should settle around a much lower level of 295,000 m².
Hybrid working models and increasing digitalization influence not only the space requirements, but also requirements regarding the quality of these areas. For example, there is an increasing demand for well-located, modern spaces that strengthen the identification of employees with the company and can be used flexibly as needed. As concentrated individual work is increasingly done from home, the office becomes even more important as a place of communication and exchange. Even though cyclical demand for office space has recently increased significantly, the change in how we work, particularly for properties in poor microlocations, is leading to persistent vacancies.
While many cities have seen such an increase in the number of vacant offices, the reverse is true for apartments. Accordingly, the question of whether empty offices can be converted into new apartments is becoming increasingly significant.
However, in the case of a potential conversion project, legal, structural, and economic issues must be clarified. Is the conversion compliant with zoning? This issue is cited by project developers as one of the main barriers to an increased conversion of office buildings. If so, are the location and building even suitable? There are a number of challenges to consider in connection with conversion:
The necessary structural measures to convert office space into living space can result in high costs. For such projects, around 75% to 80% of new construction costs are often assumed as a guideline. However, there are studies that show that the financial expenses can be as high or even higher than for comparable new construction projects.
From an investor's point of view, the high construction costs are not an obstacle per se, provided that sufficient income can be generated from the renovation. In addition to the property-specific conversion costs, the expected rents and vacancy rates for the respective segments are therefore particularly important. Specifically, it is important to consider how much lower the vacancy rate and how much higher the rental price per square meter must be in order to compensate for the costs associated with the conversion and to achieve at least the same return on a likely smaller area.
In Switzerland, Bern and Zurich are among the pioneers in the conversion of office space to living space. However, across Switzerland, conversion is still quite rare. This is explained not so much by structural obstacles, but rather by the often insufficient profitability, which is due to the high construction costs on one side and the low difference in rent between living and office on the other. Given the sharp rise in prices for commodities and construction materials and the increasing weight of sustainability considerations, the question of whether the renovation of an existing property is worthwhile compared to demolition and new construction is now becoming even more important.