2020 Archives
TenantSee Weekly
Market Outlook Q4 2020
THE OFFICE WAS CHANGING
To understand the magnitude of change brought on by the COVID-19 pandemic, we must first acknowledge that significant changes had already begun over the past couple of decades. To be sure, corporations were thinking differently about office space. They had become more resistant to the historical misalignment that exists between their need for flexible, amenity rich solutions and the traditional landlord lease offering. Most notably, landlords require fixed, long term leases; whereas over the course of the lease, the occupier’s business is in constant flux. Enter the likes of WeWork and the rapid rise of flexible leasing solutions.
Similarly, during the early 2020s landlords in all US Metros began to make expensive physical changes to their assets. They waged an “amenity war” in which significant capital was invested to enhance the occupier experience within the building. High end fitness facilities, casual gathering spaces, outdoor patios and roof decks, “activated” lobbies and many other changes became part of the standard landlord playbook.
Occupiers across all industry increasingly embraced the open architecture and higher density occupancy first espoused by the tech sector. Many companies also demonstrated willingness to pay more for the finished product by leasing pre-built space. Landlords wasted no time gravitating to this model, launching a years’ long love affair with the “spec tech” prebuilt.
Meanwhile, corporations were getting more comfortable with new technologies that enabled workers to work from anywhere. However institutional bias against WFH/ remote work prevented these technologies from being fully deployed. The primary reason? Trust. Trust that the WFH/ remote employee would remain productive.
All in all, US office markets entered 2020 at a time when big changes were taking shape, portending a future where office space would be significantly different than it had been for most of the prior century. But what happened in March of 2020 accelerated and amplified these trends. The result has been no less than a wholesale reexamination of the modern office.
THE COVID-19 ACCELORATOR
Has there ever been a moment when a product used daily by hundreds of millions of people was taken away overnight? This is effectively what occurred across the US office markets beginning in March of 2020. Employers and employees were forced to quickly adapt their businesses to function without office space. To the surprise of nearly everyone, business carried on. Employees were productive, in some cases more so. Some found great relief not having to commute.
Others became healthier, filling time they otherwise wasted on long commutes with exercise and family time. Yet challenges emerged. Employees experienced burnout as they struggled to create work/life balance. Some had inadequate workspace at home. Others could not manage the constant distractions, including caring for young children or elderly parents. Still others lacked quality technology and internet connectivity. It was challenging to define, promote and maintain culture. Mentorship of young employees also suffered. But as the year progressed and the virus continued to spread, offices remained closed and companies began to think differently about their future use of office space. Here in the Bay Area, it was no surprise to see technology companies lead the way. After all, tech as an industry has done more to redefine office space than any other sector. It was tech that brought us benching, lounge spaces, fun and games at work, company chefs and much more. Now tech is leading the way in developing hybrid workplaces, embracing the distributed workforce, advocating WFH forever and other remote work policies.
Yet while Google and Facebook have a plan, it’s clear that many companies do not. To remain competitive, these companies must also determine their future workplace. They must determine how they will support their employees, employees who after nearly a year of adjusting to an “officeless” lifestyle may demand more of the same post-pandemic. No small task when you consider the magnitude of these changes and that to be effective, new workplace strategies must be custom tailored to meet the individual employee needs. One thing is certain, office space now means something different than it did in 2019.
FUTURE WORKPLACE
Out of the chaos of crisis examples of new workplace strategies have emerged. Most of these can rightly be described as hybrid solutions because they offer employees at least some flexibility to be in the office, WFH and work from other remote locations that are not home. The office space is being recast more as a center for collaboration, culture building and client facing activities. It also provides space for “head down” work for those who are not able to do so at home. There is a lot of chatter about so called “hub and spoke” workplace solutions where a company maintains a main office in the city and provides smaller, distributed remote locations near where concentrations of employees live. It’s not yet clear whether the amount of space required to implement these strategies is less than, equal to or greater than the amount of space previously leased. While difficult for many to envision their future office, it’s imperative to do so as those failing to respond to the changing landscape will be less competitive as they lose in the war for talent. Ultimately this is about attracting and keeping talent. Finding the right path forward requires proper guidance and key input from employees, HR, Workplace and Finance. Lacking a playbook for this new journey, many occupiers have chosen to hit pause and either do a short-term extension on their existing leases or simply allow the lease to expire and WFH. These are smart strategies when compared to moving forward on longer term commitments based on the model otherwise employed pre-pandemic.
THE OFFICE MARKET
In 2020 San Francisco recorded the lowest amount of new leasing on record. THE LOWEST AMOUNT OF NEW LEASING ON RECORD. For landlords, the year began with an opportunity to continue to exploit a severely constrained market characterized by over 7M sf of demand and just 4% vacancy. By June measurable demand plummeted to around 3M sf. With nearly all occupiers unable or unwilling to use their office space, sublease space surged. In fact, sublease availability quickly outpaced direct availability. Overall vacancy climbed from 4% to over 16%. Pricing for sublease spaces began dropping precipitously. Many offerings initially hit the market priced in the $80s.
By year end, sublease space was commonly available in the $40s and $50s. Meanwhile, pricing of direct space has declined but at a much slower pace. Average Class A rental rates started the year in the low $90s (a historical record high) but finished in the mid $70s. Remember, most landlords have continued to enjoy low vacancy while their tenants honor their leases and pay rent. The brunt of the pain has, thus far, been shouldered by tenants. But as the burden of vacancy begins to shift to the landlord, forcing them to compete in an oversupplied market, the pace at which direct rents fall will accelerate and landlords will fund more tenant concessions.
It’s clear the demand now returning to the market is patient. These occupiers are not forced to act based upon expiring leases. With employees already in WFH mode and ongoing uncertainty as to when the office will once again be safe for occupancy, letting the lease expire and storing FF&E is a real option. Many are using this moment to craft solutions that better match their future need; and, frankly, the market is compliant.
2021, 2022, AND BEYOND
The San Francisco Bay Area office market now affords occupiers the opportunity to exercise substantial leverage in negotiating new workplace solutions. While the uncertainty around how to proceed is real, smart companies will immediately undertake the work necessary to design their future workplace so they can implement this strategy while the market is historically soft. Those who do so will enjoy competitive advantages for years to come. Remember, Bay Area office space is unique in that the same exact product (e.g., the same office space) can cost twice as much or half as much, simply depending upon when it is acquired.
More than 2 years ago when we created TenantSee, we focused on change. We wanted to change the way tenant real estate services are conceived and delivered. It should come as no surprise that we’ve worked very hard over the past year to augment our platform with resources designed to meet the needs of this moment. Specifically, we have a service to help companies navigate the new realities of workplace. This is not a brokerage solution. It’s a consultative offering that begins with “why”; as in: Why have an office in the first place? We’ve mapped out the exact resources necessary to determine the best hybrid solutions. How much WFH? Where is your labor? What technologies do you need to measure employee engagement, to measure space usage and employee experience? How much flex do you need in your portfolio? How should your future space be designed? The output from this effort is a new Workplace Strategy which correlates workplace spending with key employee engagement drivers. We can provide an overview of our offering in a 30-minute virtual meeting. Please let us know if you would like to learn more.
As we close out 2020, I’m reminded of the words of President Abraham Lincoln, “…this, too, shall pass”. The COVID-19 pandemic won’t last forever. Office markets will cycle. They always do. Opportunities will come and go; and come again. But the way we think about and use office space is forever changed. We now have an opportunity to make it better. Better for the employees, creating more engagement, making them healthier and happier. We look forward to being part of this positive change. As always, thank you for your support and interest in our work.
TenantSee: Modern Solutions
Office space is a physical environment in which employees gather to fulfill the goals of the corporation, the most obvious being profit. The way employers use office space has continuously evolved over the years most notably as new technologies emerge. Over the past 2 decades many technologies have been developed that would otherwise enable a significant shift in the way we work, especially in terms of where we work. However, notwithstanding the presence of these technologies, employers have mostly been reluctant to fully embrace their use due to uncertainty around how such changes would affect productivity and culture. The covid-19 pandemic forced everyone to embrace tech, shifting most workers from offices to working from home. Employers have been surprised to find their worst fears unfounded.
Armed with the knowledge the enterprise can survive, occupiers find themselves having a new conversation about workplace solutions. This is among the more valuable corporate undertakings of the past century. Why? Because office space is not really about buildings, location or even cost…it’s about supporting and promoting employee engagement. Engagement can be defined in a variety of ways but the simplest way to think about it is in terms of how well the employee is thriving. A thriving employee understands, is connected to and contributes to the corporate culture. She is healthy and happy. She is loyal and disinclined to seek other opportunities. She is productive. There are many drivers that contribute to employee engagement but the workplace is among the most impactful.
Yet the changing nature of workplace has become a source of confusion for many companies. For while it’s clear the old playbook is no longer reliable, there is a shortage of resources available to help create a new one. Most of the real estate service firms have been caught flat footed, lacking the capabilities necessary to guide customers through a more modern journey. They remain focused on finding space and term negotiation while their clients are seeking guidance on “why”; as in, why have an office in the first place? When we first developed TenantSee, we knew changes were coming but we certainly did not anticipate a dramatic catalyst like the covid-19 pandemic. We believed corporate occupiers were in the early days of a shift in how they view office space, moving from a focus on measuring cost of space to one in which employee engagement became the primary metric by which the workplace is valued. We knew then that incremental increases in employee engagement are worth substantially more than cheaper rent. We set out to give our clients better tools to more fully address their approach to office space. Our thesis was (and remains) that every company should think about office space as a repeating cycle of the following stages.
Stage 1: Create the Office
A deliberate workplace consultation that involves executive sponsorship from HR and Finance. The goal is to create the optimal office solution before going to market to find space. What are the key drivers that enhance employee engagement within your company? How can your office solution support these drivers? Where should the office be located? How should the office be designed? How fluid is this need? How flexible must this solution be?
Stage 2: Define the Strategy
What approach will be taken to get the optimal office you’ve created in Stage 1? What are the strategic considerations that will lead to achieving your goals while maximizing market leverage?
Stage 3: Execute the Strategy
This is the activity typically associated with real estate brokerage. It involves site selection and negotiation of terms and the legal document.
Stage 4: Measure the Efficacy
TenantSee deploys Cushman & Wakefield’s Experience per Square Foot resource to measure employee engagement within the workplace (wherever that may be). It’s important to document where and how the workplace solution is working, how it meets the objectives you set when first creating the optimal outcome.
Stage 5: Manage the Facility
The TenantSee platform facilitates ongoing management of key dates, portfolio analytics and storage + maintenance of all critical data.
These 5 stages represent an evolved tenant service offering that marries teams of subject matter experts with technology to properly address the full spectrum of occupier need. As office solutions rapidly evolve to offer employees greater flexibility and increase engagement, it’s more important than ever for occupiers to have a full-scope resource. This is a time of great change and while change can be difficult, at TenantSee, we believe this is also a time of great opportunity. Opportunity for our clients to craft better solutions that enhance corporate productivity by increasing employee engagement and reducing employee turnover. Please contact us if you’d like to learn more about our modern solutions.
Why Office Rents Fall Unevenly
Over the past decade as demand surged and supply became increasingly limited, office rents rose uniformly across the bay area. But now that demand is waning and supply rising, don’t expect landlords to make downward price adjustments in unison. Landlord behavior varies by type of landlord (private capital, REIT, institutional fund), debt and equity, stability of tenancy and cost basis. While product type may be comparable (e.g., class A office buildings in the San Francisco financial district), individual owner motivations reflect the highly differentiated interplay of these variables.
Type of Landlord
There are 3 basic types of landlord:·
Private Capital·
REIT·
Institutional Fund
Private Capital owners are generally motivated by cash flow. They favor limiting capital spending, minimizing risk and maintaining continuity of tenancy.
The REIT, or real estate investment trust, is a publicly traded entity which owns assets typically focused by asset class. A good example is Boston Properties (BXP), a large office REIT owning assets across the US. REITs favor occupancy and maximization of rental income in order to achieve highest possible levels of Funds from Operations (“FFO”), which is the measure by which REIT stocks are valued.
Institutional Fund landlords are comprised of investments from endowments, pensions and insurance companies, to name a few. These funds are typically run by operating entities that also have a small amount of equity in the investment. Each fund has an investment thesis and targeted returns over a defined period.
Debt and Equity
In past downturns, debt to equity ratios were significantly higher than those typically seen today. In fact, debt levels were so high in the early 2000s that a good number of assets became known as “zombie assets" where the operator was effectively unable to transact because it (and in many cases some percentage of the debt holders) had lost all equity. Large office buildings can have complex ownership structures involving multiple equity partners and multiple layers of debt. As the market declined in the early 2000s asset values fell through the equity and debt stack, at times leaving only debt holders down the stack with enough incentive to “own” the asset.
Stability of Tenancy
Multi-tenant office buildings can have dramatically different circumstances when it comes to stability of tenancy. Assets having significant lease rollover in the near-term will be more inclined to transact in a declining market since the alternative is more vacancy, taking longer to lease; whereas, landlords of assets that are highly occupied over the mid-term and long-term may choose to sustain modest levels of vacancy through the downturn in order to avoid transacting at discounted rental economics, thereby preserving future target valuations.
Cost Basis
Ultimately, landlords are people. People who convince their investment committee to buy at a certain price. People who secure investors with target returns. People who have compensation tied to the performance of the asset. No one wants to tell the partners/investors the bad news. When it is revealed, it often comes in stages as the operator remains overly optimistic despite clear signs of a deeper downturn. This is simply human nature. It’s noteworthy that in San Francisco where investment volume has been record-high over the past 10 years, asset values have appreciated significantly. In fact, numerous assets have traded multiple times during the cycle at increasingly high values. For many San Francisco landlords cost basis is at an all-time high. There’s a high degree of reluctance to accept reality built into the current market.
Summary
Achieving market-favorable leasing outcomes in a declining market requires a thoughtful negotiating strategy that includes understanding unique landlord motivation profiles. Negotiating strategies must be sensitive to factors influencing landlord motivation. Occupiers must have access to critical data and advisory teams that understand how to analyze this data to inform strategy. While the pace of decline will be erratic, the balance of leverage has shifted to the tenant and this trend will accelerate over the next 12+ months. TenantSee, powered by Cushman & Wakefield, combines data and teams of subject matter experts with powerful technology to create total transparency for office tenants. TenantSee Market Diagnostics illuminate and analyze critical data to provide actionable insights. Contact us to learn more about our complimentary diagnostic resource. ~
How To Sublease with Success: The TenantSee Approach
Recessionary pressures often result in reduced hiring and/or lay offs, leading to excess office space. The COVID - 19 Pandemic has forced many San Francisco tenants to look to the sublease market to mitigate the expense of excess office space. Over the past decade it has been relatively easy for occupiers to secure subtenants, often at a profit. Yet in times of macro-economic uncertainty, many tenants are surprised to learn their space is worth less (sometimes considerably less) than their cost basis. This is one of those times.
Successful space disposition in a decelerating market demands a thorough, disciplined approach. Such efforts should begin with a sober assessment as to how much of the remaining obligation can be recovered after considering expenses (legal fees, commissions, concessions, etc.). As with all tenant real estate, the quality of up-front due diligence correlates directly to the quality of the outcome. Among the essential steps involved in the initial underwriting are the following:
Audit Sublease and Assignment Lease Language
Prohibitions
LL recapture right(s)
Profit
Assess Intra-Building Demand
Existing vacancy
Growing tenants
Assess Competitive Market
Scale of comparable offerings
Pricing
Features, Quality
Assess Market Demand
Number of tenants actively seeking comparable space
Assess Space/Recommend Changes
Exiting
FF&E
Design
Staging
Identify Prospects
Assess Landlord Motivations
Lease termination in lieu of sublease
Establish Project Timeline
Marketing
Negotiation
Sublease commencement
Model Projected Recovery
Best Case
Base Case
Worst Case
Establish Budget
Legal fees
Broker fees
TI
Other
Define Offering
Available space
Timing
Asking rate
Other concessions offered
Create Marketing Campaign
Digital
Other
Outlets
Cadence
Reporting
Time is among the most critical factors influencing outcomes as occupiers look to dispose of excess space. This is true as every month of vacancy erodes recovery, limits remaining term and increases the challenge of securing a subtenant due to the flow of new supply coming to market. Occupiers looking to sublease space are right to demand transparency from their advisor, to require access to all the critical data informing and supporting the advisor’s recommendations. This is not a time for half-baked marketing schemes. TenantSee, powered by Cushman & Wakefield, brings together teams, resources and technology to create better outcomes. Among the technologies TenantSee deploys to enhance space disposition is Matterport, a technology that facilitates high quality virtual space touring as can be seen here in this currently available space offering.
In just 48 hours, our team can provide an initial diagnostic for any space disposition you may be considering. Our initial diagnostic is free and provided without obligation to contract for services. Contact us if you’d like to learn more. ~
Proceeding Cautiously In Uncertain Times - TenantSee Service Directory
Among the many reasons we created TenantSee is our belief that tenant real estate services should be full-scope, easy for occupiers to access and delivered with total transparency. Most real estate service providers simply don’t have the scale to address the entire spectrum of occupier need. The handful that have such scale require tenant clients to navigate a maze of siloed service lines that are poorly integrated with conflicting agendas. TenantSee, powered by Cushman & Wakefield, offers occupiers industry-leading resources accessible through an award-winning technology platform from which services and outcomes are delivered and measured with transparency.
This directory offers a brief overview of the most relevant services TenantSee can bring to occupiers now as they look to respond to the COVID – 19 Pandemic. Many companies are struggling to find a path forward with their facilities, to understand which steps to take and how to prioritize their actions. For this reason, we’ve organized the directory based upon the sequencing of when to engage with the highlighted action. The most important first step is to ensure the health and safety of your workforce. This is not a time to rush into reactionary solutions. For example, many are realizing that a larger percentage of their employees may be able to effectively work from home indefinitely. But how do you measure the true efficacy of work from home? Which employees want more of it and which can’t wait to get back to the office? How does the employee’s specific health, commute and home circumstances impact the desirability of work from home? What are the cultural implications? Work from home is here to stay but for it to be a meaningful element of a sustainable workplace strategy, its scale and implementation must be studied rigorously and planned thoughtfully. Similarly, this is not a good time to significantly redesign your workplace. Better to do the minimum to address health and safety, buying more time to achieve the optimal outcome. “Proceed with caution” is a good mantra in these changing times.
Employee Health and Safety: Reopening Procedures
Recovery Readiness – Reopening Your Offices
Design/Technology
Space planning and furniture planning services, expressed in 3-D and virtual, to ensure appropriate social distancing measures in the workplace
Evaluation of technology systems critical to maximizing employee productivity both in and outside the office
Xsf (Experience per Square Foot)
Proprietary consultative product to assess employee engagement
Also Xsf@home to study employee engagement in work from home environment (need >50 employees to implement)
Here is a whitepaper on Xsf
Portfolio Analytics/Labor Analytics
Assess and prioritize sites
Visit www.tenantsee.co to learn more
Market Diagnostics
Here is an example of our Market Diagnostic
Identify target labor
Metro comparisons
Develop and implement portfolio strategy
Space Disposition/Lease Termination
Audit sublease and assignment rights
Detailed review of relevant lease clause(s)
Profit sharing
Landlord recapture right
Notices
Prohibitions
Underwrite recovery
Model best-case, base-case and worst-case recovery scenarios
Compare sublease vs. termination
Develop marketing plan/materials
Here is an example of a marketing brochure
Implement disposition/termination campaign
Rent Relief/Lease Restructure
Develop and implement strategy
Each circumstance is unique
Experience-based approaches that fully contemplate both tenant and landlord outcome
To learn more, please see our contact information at www.lowfogg.com/about