Rental Rate: A Poor Proxy for Value
Historically, rental rates have played an out-sized role in determining where companies lease office space. Today, as companies address leases they negotiated in 2010 – 2015, they understandably do so against the backdrop of the pandemic. The fact that many companies have not yet fully returned to their offices has created a sense among occupiers that rental rates should be substantially lower (e.g., the office market must be very soft since no one is there). But paying for space and using space are 2 different things – landlord rent collections remain high (~98%). San Francisco rents are down. But as of Q3, citywide average rents stand at $73.46, down only 12.4% from the pre-pandemic high; and class A CBD asking rents are $84.91, down just 7.4%. Hence, in most cases, tenants having leases expiring in 2022 and 2023 will find their rent is actually increasing from the in-place rate. This gap between expected outcomes and market reality can sometimes cause occupiers to make poor decisions. Rate, alone, is not a good measure. Total occupancy cost per employee is better. But the real question is what do you get for the cost? How does the occupancy cost impact the following:
Promotion of employee health and wellness (outdoor space, air quality, natural light, fitness, etc.)
Flexibility (contraction, expansion, term, etc.)
Design Agility (mobility of furniture systems, change management)
Employee engagement (how well the space promotes engagement)
Recruitment/Retention of key talent
This is not to suggest financial considerations don’t matter. They do. Most companies have budget constraints. But in the context of evaluating which office leasing solutions best serve the company (e.g., the employees), a myopic focus on rent will often lead to the wrong outcome.
So why is rent such a common measure of value? Laziness. The office lease is a complex construct that includes many variables and has broad impact on the company. Assessing and measuring leases on the basis of these broader impacts is harder, requiring a more thoughtful approach. It’s much easier to simply study the cost of option A vs. B. Yet even with respect to cost, there is way more to consider than rent. Space design and construction, for example, can lead to vastly different capital spending from one space to the next.
Before the pandemic, office tenants were beginning to evaluate space more from the perspective of employee impact (largely led by the tech sector). But the pandemic has accelerated this trend. If your company is still making leasing decision based purely on rental rate, it’s time to change the conversation. Your best competitors have already embraced the connection between employee engagement and space and are focused on creating optimal employee experiences through the spaces they provide. These companies will leverage their offices to attract key talent and strengthen their competitive advantage.