We see a lot of confusion in the market around when to begin negotiations. It’s not an insignificant consideration. In fact, when you begin can make a huge difference in the outcome. It’s understandable that tenants would not know when to start. Brokers are not always keen to start at the right time, since compensation is derived by transacting and the closer the tenant is to lease expiration, the faster it will need to transact (and the fewer options it will have). Good for the broker, bad for the tenant. This creates a misalignment of interests that discourages thoughtful consultation on the front end – the more time a broker spends on a project, the lower the compensation.
Throughout 2020, the prevailing sentiment among investors in the San Francisco office market was one of relative optimism. After all, despite the fact tenants were prohibited from occupying their buildings, they continued to collect full rent. The buildings were full, with vacancy hovering around 4%. Sure, companies weren’t happy about paying for space they couldn’t use, but business was good. In many cases the tech sector (which makes up most of San Francisco’s office occupancy) was booming due to an even greater reliance on and usage of tech caused by pandemic driven changes in how people were living. Throughout the course of 2020 there was no reason for San Francisco investors to panic, as few (if any) office occupiers were showing signs of developing long-term hybrid or remote-first strategies. Most were simply focused on solving for ongoing operations as a temporary reaction to the pandemic. Yet early indicators did point to a future in which companies would be shedding office space, as some expiring leases were not replaced. This, coupled with the addition of new supply, caused a big increase in vacancy to nearly 12% by year end. Despite this large uptick, the brunt of the sluggish demand dynamic was being felt in the sublease markets, where rental economics more accurately reflected the true state of the market. Despite a total closing of the office market in 2020, average asking rents ended the year off just 6% from the pre-pandemic high.
In the years leading up to the pandemic, most medium and small companies defined their office space need based on headcount (current and projected), space programming, and industry/sector norms. The exercise was mostly formulaic. The primary differences in the offices of a small, regional law firm compared to those of an AM Law 100 firm would be scale, the cost of finishes, and the quality of the building and views. It was planning for the same outcome, just at different levels on the cost spectrum. Companies having a larger portfolio of offices would typically create a “workplace strategy” that included guidelines around programming (e.g., space layout, office size, critical adjacencies, growth factor, finishes, FF&E, etc.). These guidelines could then be used to inform the real estate process across geography.
Negotiations are always about (or should always be about) this or that. There’s always something else, maybe that something else is nothing (as in sometimes the best thing to do is nothing at all). Decisions made without proper consideration of all relevant alternative scenarios are decisions made poorly. As important, in the context of office lease negotiations, the best negotiated outcomes are directly correlated to the extent to which we understand the alternatives of the landlord counterparty. This is a bit counter intuitive, allow us to explain.
A little AI distraction to cheer your day (and relieve us of yet another discussion about workplace). Ever wandered through the streets and felt like you've stepped into the future? With their undeniable presence here in San Francisco, the driverless car is quickly becoming the most prominent representation of AI in our daily lives. If you spend any time in San Francisco neighborhoods, you can’t miss them. The other day, as I chatted with a neighbor, I counted 6 autonomous vehicles casually cruise by our front door within a span of 10 minutes. Intriguing, right? And today, in a twist of irony, I was held up by one. Blocked by a double-parked UPS truck, the driverless car hesitated, unsure about navigating into the lane of oncoming traffic. Of course, all the drivers in the opposing lane weren’t too keen to make space for the driverless car, as one normally would (or at least the more decent among us would) for a human-driven vehicle. Hence, we waited.
AI has summarized capitalism for me as follows:
“…an economic system where private individuals and corporations own and control the means of production, such as property, businesses, and industries. In capitalism, the core principles are profit motive, private property, and market competition. The government's role is limited to taxation and standard regulatory laws, and individuals are given the freedom to operate their businesses and manage their income as they choose.”
Throughout 2020, the prevailing sentiment among investors in the San Francisco office market was one of relative optimism. After all, despite the fact tenants were prohibited from occupying their buildings, they continued to collect full rent. The buildings were full, with vacancy hovering around 4%. Sure, companies weren’t happy about paying for space they couldn’t use, but business was good. In many cases the tech sector (which makes up most of San Francisco’s office occupancy) was booming due to an even greater reliance on and usage of tech caused by pandemic driven changes in how people were living. Throughout the course of 2020 there was no reason for San Francisco investors to panic, as few (if any) office occupiers were showing signs of developing long-term hybrid or remote-first strategies. Most were simply focused on solving for ongoing operations as a temporary reaction to the pandemic. Yet early indicators did point to a future in which companies would be shedding office space, as some expiring leases were not replaced. This, coupled with the addition of new supply, caused a big increase in vacancy to nearly 12% by year end. Despite this large uptick, the brunt of the sluggish demand dynamic was being felt in the sublease markets, where rental economics more accurately reflected the true state of the market. Despite a total closing of the office market in 2020, average asking rents ended the year off just 6% from the pre-pandemic high.
Mass psychology is literally contagious (that’s how it becomes “mass”). This is especially true in times of change, when a significant event has precipitated such change (e.g., the pandemic). These events can be positive or negative. In our current state, the catalyst was negative, and, in many ways, has resulted in a decidedly negative outlook. When things turn negative, there will always be market casualties (just as a rising tide lifts all boats in the positive context). For example, the impact to investors in the domestic office sector has been mostly negative. As change unfolds, it can have knock-on impacts that weren’t necessarily anticipated. For example, the demise of urban downtowns due to shifts in daily worker population. Collective sentiment tends to aggregate around a view and stay there until some brave souls dare to take the contrarian view. As these contrarians see success, it spurs others to jump on board and the collective sentiment begins to shift, once again, in the other direction.
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?
Architecture, interior design and furniture design each impact how we feel. If you’re someone who is not particularly aware of this connection, take a moment over the coming days to note your feelings upon entering different buildings, different spaces. Notice the volume. Contemplate the impact of day light and other light sources. Consider the way the rooms are designed, the flow. What about the furnishings? Is it comfortable? Does it look interesting? Is there artwork? If so, how does it affect you? Does the space inspire you? Does it make you feel content? Does it make you anxious? Does it make you feel gloomy?
Technology used to compliment space. It was an adjunct to the physical office. However, today’s workplace is really not a place at all; rather, it’s a hub of technology resources that travel with the employee wherever she may go, which may or may not include a corporate office. Tech has jumped ahead of space as the more important element in defining the total workplace.
This San Francisco office market report is provided compliments of Samantha S. Low and Greg Fogg, co-creators of TenantSee. TenantSee is a tenant real estate product combining a team of subject-matter experts with powerful technology to make tenant real estates smarter, faster, and better. Our report is intended to provide you, the tenant, with meaningful insights, not raw data. To learn more about TenantSee, please visit www.lowfogg.com
Ever wonder how and/or how much a tenant advisor is paid? It’s an obscure compensation model. In the interest of transparency, we thought it might be useful to provide a more detailed view.
Tenant advisors (in most cases) are not paid a salary. Their compensation is usually 100% commission-based. This is among the reasons why the industry lacks diversity, both racial and socio-economic…it’s nearly impossible for someone without a measure of financial support to get started. The path to compensation begins with being retained by a client. Yet being selected to advise a client is not easy. It is typically the culmination of a long period of marketing, knowledge sharing and relationship building. Developing a meaningful relationship may take several years (and probably should). Hence a lot of the activities in which a tenant advisor is engaged are non-compensatory…they’re speculative.
Much of what we “do” every day is driven by long established norms, norms that most of us rarely give much thought. Societies always have outliers who think about things a little differently. Often, these thinkers are entrepreneurs. Their journey usually begins with “why” or “what if”. Why are most people seemingly happy to exist within the status quo? I believe it’s the discomfort created by stepping outside the normalcy bubble to think for oneself. Just spend one day asking yourself why you do the things you do and you’ll see how easy it is to imagine different solutions. Of course, you have to accept that your solutions might be worse. And should you wish to advocate for your new solutions, be prepared for resistance. People resist out of fear of the unknown, or because they have a vested interest in keeping things the same. But resistance is a powerful force against change.
Workplace equity is a big, important topic. The pandemic has helped advance a better discussion about how to create workplaces that are more inclusive, that support the specific and differing needs of the employee base. It’s not so much that we’ve learned our offices don’t serve all equally well, we already knew this. Instead, companies have been forced to address this reality head on because the concept of the office has been turned on its head. The act of creating equity when everyone was remote has (hopefully) built some institutional “muscle memory” that will serve us well as we embark on what’s next.
This San Francisco office market report is provided compliments of Samantha S. Low and Greg Fogg, co-creators of TenantSee. TenantSee is a tenant real estate product combining a team of subject-matter experts with powerful technology to make tenant real estates smarter, faster, and better. Our report is intended to provide you, the tenant, with meaningful insights, not raw data. To learn more about TenantSee, please visit www.lowfogg.com
In the early days of the pandemic there was a lot of chatter about so called “hub and spoke” real estate strategies that would cause occupiers to establish a city center hub and branch out to the suburbs with smaller satellite offices…the spokes. In the bay area, this trend has not materialized. The absence of consistent levels of demand that characterized the pre-pandemic office market has left a void for speculation. Much of the speculation comes from parties whom have a vested interest in the outcome. Suburban landlords optimistically viewed the pandemic as an opportunity for heightened demand for their product (and this may still turn out to be the case). But the truth is much of the current discussion around office demand is not informed by actual data (e.g., actions taken by tenants).
With the exception of the tech sector (where to innovate is to survive), big companies have a hard time being innovative. Why? Many reasons; but, most notably, the fact that true innovation is the enemy of the status quo. The status quo is a big company’s happy place. Innovation is messy and disruptive. It looks to upset the status quo in search of new, better ways. Most people don’t want change. This is why venture capital and startups exist. They aren’t afraid to “break it”, they’re designed to do so. The bigger the market a startup looks to disrupt, the more valuable it may be.
People aren’t really shaking hands any more. Literally. And the figurative handshake has also seen better days, especially in the context of real estate transactions. To be sure, most office lease transactions are too complex to memorialize with a handshake. However, there’s a more practical factor at play that makes trust and commitment difficult. Specifically, until there’s a deal, there’s no deal.
Markets are shaped by an ever-changing interplay of influential factors; including, supply, demand, human behavior, data and a collective narrative. In times of relative stability, market participants accept a prevailing collective narrative and the markets perform with a high degree of uniformity. Take, for example, the San Francisco office market of 2019. Characterized by strong tenant demand and limited supply, this market was not difficult to understand. The narrative, while beneficial to landlords and harmful to occupiers, was supported by data and participant behavior.
he overwhelming practice in all major US Metro markets is for landlords to pay the tenant advisor’s fee. While it’s true the landlord cuts the check, the tenant is actually the payor, as leasing fees are built into the building operating budget and recouped by the landlord through rent in the same way other transaction costs are passed on to the tenant (like landlord-funded tenant improvements, free rent and other concessions). In past issues we’ve written about how this arrangement can create opacity, making it harder for tenants to align advisory fees with specific services. But this unorthodox arrangement can also create unusual negotiating dynamics where certain landlords look to leverage tenant confusion about leasing fees to cause the tenant to sign up for less favorable terms and/or to keep fees otherwise budgeted for the tenant’s advisor.
The tenant advisory business was built on the premise that the advisor holds essential knowledge about where your office should be located and how to negotiate market-favorable lease terms. Yet much of the details surrounding what the advisor knows, how they know it and why they advocate a specific strategy are unknown to the client. Importantly, in the US, the advisor’s compensation is often misunderstood by the client since the advisor is paid by the landlord (the tenant actually pays the fee through rent). In fact, with tenant advisory fees being “at risk”, meaning they are earned only if a transaction is completed, there is ample incentive for tenant advisors to hold a strong bias toward transacting quickly, even when it may not be in the client’s best interest. Further, when the service offering is mostly opaque, the provider can increase the value of fees by limiting the amount of service required for their acquisition. This is not a cynical view of the sector. It is a reality based discussion of the structural challenges that make hiring the best advisor difficult.
Way back in 1995 we began tracking the correlation between San Francisco office rents and the Nasdaq. This has become a throw away datapoint since it rarely reveals anything new. That is until Q2 2020. This is when, for the first time in a quarter century, the Nasdaq and San Francisco rents have become uncorrelated. What does it mean?
There’s not a single decision we make that isn’t improved by access to more data. The challenge lies in gaining access to data, in prioritizing which data matters and in drawing appropriate insights from the data. For many years the business of tenant advisory involved an opaque transaction between a broker, whom had access to data, and a customer, whom did not. Given that tenant advisors are mostly paid by the landlord counter party, the connectivity between scope of services and fee is muted. This has resulted in the tenant advisory industry being built largely around 2 services, 1) site selection and 2) negotiation of basic business terms (rental economics). These services are easy to stand up and difficult for the customer to measure. Over the past couple of decades, the model has improved; but, frankly, the level of services provided to the tenant customer (in many cases) remains low. Certainly large corporate occupiers benefit from the best service platforms brokerages have to offer. But for medium and smaller companies (5,000 employees and less) there remains substantial room for improvement. Not surprisingly, technology is beginning to play a key role in changing the quality of services being offered by many brokerage advisory firms.
