When you look at an office building, what do you see? Maybe you see the architecture. Maybe it’s the neighborhood, the restaurants, and amenities. Perhaps, you see the views from within the building. This is what most people see. They’re all important. But it’s what you don’t see that matters most.
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.
To our clients and loyal followers…In a departure from our normal practice, we’ve chosen to write a letter to close out what has been a most unusual year. With respect to office space, it’s no stretch to describe 2020 as the most impactful year of the past century. What changed? In a word: everything.
The Covid-19 pandemic is not only the most significant public health challenge of our time, it is also massively disrupting the way we live, socialize and work. While corporations navigate a rapidly changing business landscape, they’re also forced to solve for new operational challenges they’ve never seen before. This is a highly complex time. Among the most significant challenges is that of creating optimal workplace solutions that foster employee health and wellness, are sensitive to the differentiated employee needs and maximize employee engagement/productivity.
Office space is a physical environment in which employees gather to fulfill the goals of the corporation, the most obvious being profit. The way employers use office space has continuously evolved over the years most notably as new technologies emerge. Over the past 2 decades many technologies have been developed that would otherwise enable a significant shift in the way we work, especially in terms of where we work. However, notwithstanding the presence of these technologies, employers have mostly been reluctant to fully embrace their use due to uncertainty around how such changes would affect productivity and culture. The covid-19 pandemic forced everyone to embrace tech, shifting most workers from offices to working from home. Employers have been surprised to find their worst fears unfounded.
Armed with the knowledge the enterprise can survive, occupiers find themselves having a new conversation about workplace solutions. This is among the more valuable corporate undertakings of the past century. Why? Because office space is not really about buildings, location or even cost…it’s about supporting and promoting employee engagement. Engagement can be defined in a variety of ways but the simplest way to think about it is in terms of how well the employee is thriving. A thriving employee understands, is connected to and contributes to the corporate culture. She is healthy and happy. She is loyal and disinclined to seek other opportunities. She is productive. There are many drivers that contribute to employee engagement but the workplace is among the most impactful.
Over the past decade as demand surged and supply became increasingly limited, office rents rose uniformly across the bay area. But now that demand is waning and supply rising, don’t expect landlords to make downward price adjustments in unison. Landlord behavior varies by type of landlord (private capital, REIT, institutional fund), debt and equity, stability of tenancy and cost basis. While product type may be comparable (e.g., class A office buildings in the San Francisco financial district), individual owner motivations reflect the highly differentiated interplay of these variables.~
Recessionary pressures often result in reduced hiring and/or lay offs, leading to excess office space. The COVID - 19 Pandemic has forced many San Francisco tenants to look to the sublease market to mitigate the expense of excess office space. Over the past decade it has been relatively easy for occupiers to secure subtenants, often at a profit. Yet in times of macro-economic uncertainty, many tenants are surprised to learn their space is worth less (sometimes considerably less) than their cost basis. This is one of those times.
Among the many reasons we created TenantSee is our belief that tenant real estate services should be full-scope, easy for occupiers to access and delivered with total transparency. Most real estate service providers simply don’t have the scale to address the entire spectrum of occupier need. The handful that have such scale require tenant clients to navigate a maze of siloed service lines that are poorly integrated with conflicting agendas. TenantSee, powered by Cushman & Wakefield, offers occupiers industry-leading resources accessible through an award-winning technology platform from which services and outcomes are delivered and measured with transparency. ~
