Maybe It's Time

There’s always been a large gap between what companies need from an office and what the market offers.  Over the past decade, as the coworking market rapidly evolved, landlords were forced to rethink customer experience, resulting in an “amenity war” that has made many office buildings more valuable and attractive to occupiers.  But despite new lounge spaces, high quality exercise facilities and other project-based amenities, the nature of the office lease commitment in major US metros has remained unchanged.  The product is still designed to lock in tenants for the longest possible term at the highest possible price, while minimizing the amount of capital the landlord must spend to win the tenant.  Addressing the gap between occupier and landlord objectives may be what’s next in the evolution of the office.

What if a new office product was developed that was pre-built to a high-quality standard and delivered, fully furnished, on flexible terms.  A product that functions more like the short-term sublease market (e.g., fully designed, furnished and ready for occupancy).  Would occupiers pay more for such an offering?   In most US metro markets, a company seeking to lease 5,000 sf of office space will be required to make a minimum 5-year commitment.  Yet for many companies, the business will change significantly over 5 years.  At $50/sf/year the lease costs $1.25M.  The typical tenant will spend an additional $250,000 to furnish and wire the office.  What if the same quality space was available on flexible terms?  Would it make sense for a company to pay twice as much in annual rent for the flexibility of leasing the space for 1.5 years?  Would it be worthwhile for the landlord to make the investment and take the risk of shorter-term occupancies?  If you build it, will they come?    

To be sure, this model would require investors that are looking to hold over long periods of time and derive their investment returns through ongoing cash flow, as opposed to future sale pricing.  Traditional lending formulas would not look favorably upon the model, so leverage may be difficult to achieve (at least until a true market developed for the product).  Coworking and landlord-built spec spaces are two ways in which the markets have moved toward creating better solutions.  But there are limitations to both.  Coworking, for example, generally relies on high-density occupancy of multiple companies in the same space to generate its return.  And even though operators have pivoted to “enterprise” models, offering single tenant occupancy, in the end, these solutions behave much like traditional leases.  The spec space landlords build is typically designed to appear ready to occupy (in order to gain tenant interest more quickly) but these spaces often require considerable capital investment prior to occupancy.  Importantly, landlords still rationalize their capital investment in the space over long-term leasing strategies that don’t deviate from their typical offering.  In short, the market has yet to create a product that fully addresses the dynamic needs of the tenant customer.  Maybe it’s time?