TenantSee Weekly: Translating the Lease
Recently, we completed a lease for a client in a small San Francisco building. The transaction was negotiated to provide our client with a tenant improvement allowance, and the right to manage their construction. Because the client is a design firm, this approach suited them well. They understand design and construction and can leverage relationships to mitigate cost. The ownership of this building is not an institution, its management team lacks the sophistication you would otherwise see with professionals working for larger institutional owners. The lease provided the landlord with the right to approve the plans prior to construction, but it notably lacked a specific mechanism for communicating such approval. Our client provided detailed plans. They received a few minor comments/questions to which they responded promptly. Otherwise, the landlord agreed to the project schedule and let them commence their construction – implicit approval. During the construction, the client invited the management team to attend weekly meetings, to walk the space and generally sought to keep them informed (under no obligation to do so). Despite a few bumps along the way (the building had non-compliance in a few areas and a small amount of hazmat was discovered), the project was successfully completed. However, after moving into the space, the landlord sent a letter stating numerous elements of the construction had been completed without its approval, and the space must be restored at the end of the lease term (an undertaking which would cost hundreds of thousands of dollars). Naturally, our client was concerned. Thankfully, they sent us the letter and asked for our guidance.
TenantSee Weekly: Wayne Gretzky and the Young Generation
Wayne Gretzky attributed his success, in part, to his ability to “…skate to where the puck is going, not where it’s been”. This was among the skills that made him a great hockey player. This same skill can help companies and individuals be more successful in business. Yet it’s not what comes natural to us. Have you seen young children play hockey, soccer, or similar sports? A child’s first instinct is to go where the puck or the ball is, resulting in a highly ineffective throng of players. In business, it can also be hard to go where others are not. It requires instinct, thorough analysis and understanding of a market; and, most importantly, confidence to stay the course.
TenantSee Weekly: Social Facilitation
Here’s how ChatGPT defines social facilitation: “Social facilitation is a psychological phenomenon that refers to the influence of the presence of others on an individual's performance of a task. It describes how the mere presence of other people, whether they are spectators, colleagues, or competitors, can affect an individual's behavior and performance.” In 1898, Indiana University’s Norman Triplett studied cyclists to determine differences in performance when racing other humans vs. the clock. He found, “…bodily presence of another contestant participating simultaneously in the race serves to liberate latent energy not ordinarily available…” I’ve experienced my own version of this in training for and running marathons. Without fail, I was always able to run faster and farther when in the presence of others. It turns out we have the capacity to do better, to do more, but reaching that next level is not easily accomplished alone.
TenantSee Weekly: Timing the Downturn
Since the pandemic, the cost to lease San Francisco office space, but for the most premium segment of the market, has steadily declined. The pace of decline is beginning to accelerate as more landlords capitulate to unprecedented vacancy and reduced demand, just as more companies are (finally) taking a longer-range approach to workplace. For occupiers, this provides a welcome respite from the relentless effects of a decades-long dynamic in which the office market was both too tight and too expensive.
TenantSee Weekly: It's About Trust
Getting More for Less.
Companies aren’t families. The employer/employee relationship is governed more by economics (math) than trust. This is at the heart of the ongoing struggle between employers and employees over return to office and asynchronous work. Let us explain.
TenantSee Weekly: The Lingering Fog of a Bull Market
The Lingering Fog of a Bull Market.
Advisors on the right side of a bull market end up looking good, no matter what they do. This was certainly the case for landlord advisors in the San Francisco office market for the ~10 years leading up to the pandemic, a time when you could win for losing, as the deal you failed to make was often (quickly) replaced by a new deal at better rental economics due to rapidly appreciating rents. Today, both landlord advisors and the investors they advise are, in some cases, suffering from the lingering effects of the bull market.
TenantSee Weekly: The Artificial Floor
Currently, there’s a lot of downward pressure on rental rates in the San Francisco office market. This is caused by a massive uptick in available space (4% to over 30+%), the proliferation of subleases in which the sublandlord is motivated to mitigate cost, not achieve target NOI, and the presence of owners having a materially lower cost basis, either through a long-term hold strategy, or a recent acquisition at steeply discounted pricing, both of whom can compete at much lower rental economics. Indeed, the economics being offered by these parties stands in stark contrast to those offered by landlords who bought or refinanced in the years running up to the pandemic. This latter category, by the way, encompasses a large swath of the market. These investors are struggling against a confluence of factors, including rising interest rates, maturing debt, rising insurance costs, decreased demand, lack of capital, and valuation outcomes that put equity and debt underwater.
TenantSee Weekly: Meet WALT
WALT, or weighted average lease term, is an essential metric in the valuation of office buildings as it forecasts the stability of future cash flow. WALT was less important back when office markets like San Francisco were seeing aggressive year over year rent growth. Back then vacancy was worth more than leased space, the theory being a buyer could take advantage of vacant space to capture higher rent (necessary to justify inflated pricing which baked in aggressive rent growth assumptions). However, in the broader historical context of valuation, the idea that vacancy is worth more than occupancy is antithetical to defining value. Indeed, the more prevalent (and logical) approach to value hinges on the quality and duration of the net operating income. Of course, this approach is less sexy as it disables a seller’s capacity to “sell the dream”. The buyer is buying stability and yield, both of which are measurable going in.
TenantSee Weekly: The Disconnected Worker
I read an article recently about layoffs in the tech sector. In it, one worker shared her story of being laid off by 3 companies in less than a year. The first was a startup where she had worked for several years. She questioned why she had been selected – it clearly felt personal. The next 2 employments were each of short duration, the last being merely a month long. In the end, she was left questioning whether she wanted to continue working in tech. The tech sector, especially the startup segment of the tech sector, has never been a great place to seek job security because of its inherent volatility. Yet it has long been a place in which employers seek to espouse winning and attractive cultures that are all about “the people”. This got me thinking about job security in the post-pandemic workplace. Has employment in the information economy become more unstable because there is less connection between employer and employee? Is the relationship between employer and employee becoming more transactional?
TenantSee Weekly: Sublease, Terminate, or Restructure
Subleasing is the most common approach occupiers take in mitigating the cost of underutilized space. Yet in San Francisco, it has become increasingly difficult to sublease office space. With recoveries ranging from 0 to 25%, companies must consider the full spectrum of options. Remember, too, sublease recoveries can be expensive to execute (fees and concessions); and, in subleasing, the occupier takes on a variety of risks that can prove costly (e.g., subtenant default).
TenantSee Weekly: Knowledge, Leverage, and Opaque Markets
An office lease is a unique financial transaction. While supply data is widely available, the values associated with completed leases are not so readily available, nor is the financial position of the landlord and its partners. In effect, despite the preponderance of available data in residential markets (e.g., Zillow, etc.), office markets remain opaque. The educated occupier can certainly access more information today than in decades past. But it’s not enough to merely know available spaces. Achieving a complete understanding of the markets can only be accomplished by partnering with a firm which is engaged in the market in a variety of very specific contexts. You need an intimate understanding of landlord motivations, capital structures, and even the intricate dynamics of tenants within a building. Yet many real estate service firms don’t have this information because they lack the practice groups.
TenantSee Weekly: Cap Stack Woes
Recently, we have written about the importance of understanding the landlord’s “cap stack” (capital stack, meaning equity and debt). Understanding the cap stack that guides a landlord's decisions is more than just a business detail — it's an integral part of the current real estate landscape. Today, there is a massive chasm between what many owners can afford to do in the current market and what they need to make a deal accretive or even break-even, given the capital stack realities of the underlying market. In short, many owners simply cannot afford to transact at market. Why? Two primary reasons:
TenantSee Weekly: Pandora's Office: Part IV - Wearable Work
Today, we examine the transformative role of Artificial Intelligence (AI) and automation in the workplace. AI will have broad impacts on work in the information economy, both in how and where work is done. While it's true AI and automation could lead to significant job displacement, it’s also true that AI will create new jobs. Studies suggest that AI will affect job transformation more than destroying jobs, altogether. It automates parts of jobs, not whole jobs. The nature of some roles may change, requiring a focus on skills that AI can't replicate – creativity, critical thinking, emotional intelligence, and complex problem-solving. For those at the top of the food chain, this shift will make jobs more strategic and rewarding, enhancing employee engagement and productivity. Yet jobs at the lower end of the white-collar spectrum will be susceptible to displacement.
TenantSee Weekly: The Case for Diversity
Shawn Achor’s excellent book, “Big Potential” references a study by Alison Reynolds and David Lewis detailed in the Harvard Business Review which measured the performance of teams based on “cognitive diversity”, or the spectrum of thinking styles among the team members. It was found that more diverse teams consistently outperform their more homogenous counterparts. Achor notes that, in many cases, despite the benefits of diversity, corporate leaders instead favor like-mindedness among team members. This tendency stems from the misguided belief that diversity breeds discord, hindering the team's overall function. Herein lies a fascinating truth: diversity indeed catalyzes friction, but it's this very friction that fuels better outcomes, sparking innovation and creativity.
TenantSee Weekly: AirOffice
Have we reached the point at which the office product might be consumed like the hotel, or the homes and rooms rented on platforms like Airbnb? We’re certainly moving in that direction. Companies like Upflex (a Cushman & Wakefield partner), The Instant Group and others aggregate global facilities for easy access via technology apps. This transition resonates with the growing demand for flexible, location-independent work solutions, allowing employees to effortlessly book an office space wherever required. I’m in Denver, I go to my app, enter my requirements (much like I would do on Airbnb) and, voila! my space is ready. The question is: are we ready to redefine our workspace consumption in line with the on-demand economy?
TenantSee Weekly: Unicorn Farming
Unicorn farming is risky business. I should know. For the past 30 years, I’ve lived and farmed here on the world’s biggest unicorn farm called San Francisco. Growing unicorns requires massive investment. Care must be given almost exclusively to fueling their mythical growth. They’re highly susceptible to infection by ethics, laws, economic reality, truth and any number of other real-world impediments to growth.
TenantSee Weekly: Solve for Experience!
US office markets are not healthy. The symptoms include reduced demand due to remote work, eroding rental economics due to mounting vacancy and broken capital stacks. The pandemic was the catalyst, but technology is the true source of the suffering. Technology is where many aspects of white-collar work are now done. I asked Chat GPT to define the office and then I asked it to define the office in 1990. Here’s how it responded:
TenantSee Weekly: IRL vs. URL
Lately, something has been bothering me (IRL). I’m losing sleep. I don’t understand how life can be IRL and URL. To me, life is only IRL – there is no such thing as URL. Technology is merely a construct that we created, presumably to make IRL better. What began slowly, now rapidly causes big shifts in how we experience life, IRL. Not all change is good. The modern office is among the high value social constructs which technology seeks to upend. The office IRL is fast becoming the office URL. Is this a good thing?
TenantSee Weekly: Swimming Naked: The Risk of Non-Performing Vacancy
Over the past decade the San Francisco office market was among the most desirable global markets for institutional office investment. Valuations increased by 100%+, and many assets traded…some multiple times. Even those that didn’t trade were often refinanced at substantially higher values, enabling the equity partners to take out significant amounts of capital. Today values are dropping as demand for office space in San Francisco is at historical lows, causing rental economics to decline rapidly. This presents unique challenges that are (typically) not entirely obvious to occupiers; namely, a full understanding of the debt and equity stack and the landlord’s ability to perform.
TenantSee Weekl: Change is Hard
While change is generally a constant state, big changes in one area can have the effect of spurring many additional changes in related areas. In most cases we’re not very good at forecasting all the add-on changes that may follow the initial change. We’re like low skill chess players, unable to see the full spectrum of opportunity and vulnerability created by our moves. And when big change requires us to take action, we often seek the comfort of doing what everyone else does as opposed to formulating our own approach. In the business world, this is a byproduct of risk aversion, or what can be called CYA at scale. Our corporate structures don’t typically provide incentive for creative, individualized responses to business challenges.
