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.
Office lease negotiations are complex, involving numerous parties (the principals and their advisors), and covering a wide range of issues, from economic to legal. The most effective negotiators are those who possess both a deep understanding of the markets, and the ability to actively listen while negotiating.
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.
Culture: noun: the customs, arts, social institutions, and achievements of a particular nation, people, or other social group.
We all want to be part of something great. We want our workplace culture to be worthy of its “Best Places to Work” status. But in many cases, the corporate “cultural persona” does not fully reflect the cultural reality.
Why? Firstly, leadership. Leaders tend to focus on the desired culture as opposed to the existing culture. It’s easier (and more uplifting) to identify the cultural characteristics you want, as opposed to sifting through the complexities of the culture you have. But when the aspirational culture fails to align with the existing culture, it results in an authenticity problem. However, you can’t fully blame leaders. Most companies lack the right incentives for leadership to invest in the hard work and difficult decisions necessary to bridge the gap between existing and aspirational culture. For example, achieving cultural alignment might necessitate terminating individuals who are financially productive but culturally cancerous. There could be entire groups within the company who behave in a manner that is inconsistent with the aspirational culture.
In tenant-favorable market environments, landlords often provide more concessions to compete for tenants. Concessions come in many forms, the most obvious being, landlord funding for tenant improvements, free rent, reduced rent and more flexible lease terms. But understanding the value of the concession is not always easy, especially relating to tenant improvements, one of the biggest economic variables in leasing.
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.
One of the more interesting outcomes from the pandemic has been the advent of a new competitive factor for landlords to contemplate when negotiating with existing tenants; namely, the possibility of no office, either as a permanent or temporary solution. When a company is willing to let the lease expire without having secured an alternative office solution, it takes one of the landlord’s most effective “levers” out of play. As we’ve written about in prior posts, landlords are very good at using time to their advantage. Historically the closer the tenant gets to lease expiration without having fully negotiated new deal terms, the more leverage the landlord has to command better terms.
Over the past decade, may office buildings in San Francisco have been sold, some multiple times. For tenants, these sales translate to material increases in the cost of the lease. Why? Primarily because of taxes.
California has Prop 13, which limits annual increases in real estate taxes to 2%, excepting at the time of a sale or financing of the asset, at which point the tax base is adjusted to market, often causing a big spike in taxes. It’s in these latter scenarios, a sale or financing, when tenants are exposed to potentially large cost increases. This is true because the tax attributable to a sale or financing is passed on to the tenant.
For every $100/sf in increased asset value, the rent increases by $1.50/sf. So if a company leases space in a building that has a tax base value of $400/sf and the building subsequently sells for $800/sf, there is a $6.00/sf/year increase in the lease cost. For a 10,000 sf lease, the added annual cost is $60,000.
Ever wonder why the office lease is 60+ pages of single spaced madness? The answer is simple. The “selling” of protection from crafty attorneys and incident-driven drafting. With the former, lawyers craft language and sell it to institutional clients as creative mechanisms for protecting landlord value. Over the years, I’ve seen “gotcha language” buried deep in all sorts of poetic BS. Firms have incentive to create these documents because protection sells. In the latter, incident-driven drafting is what happens when a tenant and landlord have a dispute and the landlord says, “…let’s draft language so that never happens again.” As you can imagine, throughout the decades, there have been many disputes and issues between landlords and tenants, greatly adding to the heft of your lease document.
It’s not uncommon to see discrepancies between corporate policy, the intent of the policy and the actual behavior of the leaders who are charged with implementing the policy. Jan Johnson and Jeff Leitner have studied this phenomenon in their work on the power of unwritten rules in shaping human behavior. I was thinking about their work as I recently participated in a panel discussion titled, “The New Geography of Work”, hosted by the Northern California Chapter of CoreNet. The discussion was fascinating, mostly thanks to the contributions of our moderator, Robert Teed of Integri Group, and the smart panel members, Kate Lister of Global Workplace, Chandler Bonnie of Dropbox and Irene Thomas Johnson of JLL.
Choppy markets lack data that point to a trendline which all participants understand and accept. The San Francisco office market is now in the choppy phase of a broad decline that has yet to fully materialize. The data is lacking both in terms of sustained tenant demand and completed transactions.
During this phase, completed transactions often seem too high or too low; whereas, once the market trend is clear, pricing becomes more unified. Resistance is a real factor. Landlords do not want to lower rent and increase concessions. But the market trend is, ultimately, fed by the supply/demand dynamic. It cares not what an investor paid for the asset, just as the impact of higher rent on the tenant’s bottom line is not a factor in determining how much rent a landlord can charge in a tight market. In the end, everyone has to play in the same sandbox.
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
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.
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.
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:
Landlords seeking to preserve future sale value have to protect the rental rate. The future sale value is tied to the building’s net operating income (“NOI”). NOI is the value achieved by deducting operating expenses and taxes from gross rent. This value is then capitalized using a cap rate to determine asset value. Hence the higher the face value of the rental rate, the greater the NOI and the higher the asset value.
This San Francisco office market report is provided compliments of Samantha S. Low and Greg Fogg, Co-Founders of TenantSee. TenantSee is a tenant real estate product combining a team of subject-matter experts with powerful technology to make tenant real estate smarter, faster, and better. Our report is intended to provide you the tenant, with meaningful insights, not raw data.
This San Francisco office market report is provided compliments of Samantha S. Low and Greg Fogg, Co-Founders of TenantSee. TenantSee is a tenant real estate product combining a team of subject-matter experts with powerful technology to make tenant real estate smarter, faster, and better. Our report is intended to provide you the tenant, with meaningful insights, not raw data.
