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.
Prop 8 allows owners to appeal for a temporary reduction in taxes when property values have declined. When granted, the relief is for a period of one year, after which point the owner must reapply. This is a important topic, as given the current state of the San Francisco office market, we anticipate a lot of owners will go to the city seeking relief.
The San Francisco office market consists of 86M sf. Currently, 18.7M sf is available, 13.7M direct from landlords and 5M for sublease. This means that 72.3M sf is leased and not being marketed for sublease. We can assume there will not be much (if any) new supply added to the market over the next several years. Demand will be the key factor in determining the market’s trajectory.
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 estate 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
What may not be readily apparent to some occupiers is the extent to which the San Francisco office market presents an opportunity to restructure leases. What does it mean to “restructure” a lease, you may ask. Well, it can mean a lot of different things, but in this case we’re talking about negotiating new terms ahead of an expiration such that the tenant receives immediate benefit. For example, say a lease has 3 years remaining at rents that are significantly above market and the tenant requires improvements to modify the space. If the tenant is willing to commit to the building for a term extension beyond the existing expiration, depending on the circumstances at the asset level, there may be an opportunity to recast the lease. The trade for the landlord is one of near term pain for long term gain. The trade for the tenant is one of near term gain for (potentially) less future gain. In a perfect world scenario, timing would work just right and the tenant would make the trade early, only to see the market turn less favorable thereby making the restructure look genius.
The office lease is a complicated contract. Once executed, but for its expiration, there’s no easy way out. In our experience, companies often give too little consideration to the exit. It’s understandable amidst the excitement of signing a new lease. Thinking about how to unwind the lease before signing it is a bit like sliding a prenup across the table to your future bride a few days before the wedding. But things happen. And things especially happen over a period of years.
Rent, or net operating income, is 100% correlated with value. When an owner lowers the rent, they reduce the value of their building. This is why many investors will do all sorts of things before lowering rent. For example, the most common approach is to provide big allowances and/or large amounts of free rent in exchange for rate preservation. It doesn’t feel great, but since it protects asset value, it’s in chapter one of every institutional owner’s playbook.
When it comes to office space, corporate leaders now find themselves stuck in the space between the forced closure of their offices in 2020 and having to conceive new workplace approaches that (somehow) foster productivity, enhance recruitment and retention and (generally) satisfy the diverse (and conflicting) needs of the employees. This is not a comfortable place. Indeed, we’re finding that many corporate leaders are unwilling to take responsibility for conceiving and executing a future workplace strategy. They fear making the wrong decision. Who can blame them? After all, given the extent and pace of change, it seems more likely for future oriented workplace strategies to fail than succeed. Who wants to take on that risk?
Finding high quality real estate services is easiest when a company is small, solving for one lease or a few leases in a small region; or, when a company is large and looking to hire a global partner that can provide a spectrum of services for managing a complex portfolio. These are the “bookends” of the market where there is the greatest alignment between the structure of the services and the client need. It’s in the middle, companies of 250 – 5,000 employees, where things get challenging. This week, we’ll explore important considerations when searching for a real estate advisor in this middle market.
Who wants to do some fun disposition recovery math?! San Francisco’s office market has been the perfect storm for occupiers looking to dispose of office space. High vacancy and sluggish demand against the backdrop of record high in place rents. While the market is a key variable in determining sublease outcome, it can be a distraction in defining the correct disposition strategy when occupiers focus on current rent values in the market at large. In the declining market, only the values being achieved on comparable sublease offerings serve as a relevant proxy for market, but even then, there is a high degree of fluidity. Why is the sublease offering valued differently than comparable direct space?
For many years my family has been coming to Vermont for summer vacation. We love the change of scenery from our urban life in San Francisco. Every morning at about 5 am the birds begin singing outside our windows, serving as a natural alarm clock. As they gently nudge you awake with their beautiful songs, the sun begins to rise. Our place is located in a town called Quechee, VT, home to a long running hot air balloon festival. It’s pretty common to hear the gentle hiss of a balloon passing overhead early in the morning. When this happens, it’s such a beautiful sight that we usually jump out of bed and run to the deck to watch. It’s a peaceful experience.
Historically, the narrative within the commercial office markets in big cities has been controlled by institutions. Institutions who own the buildings and institutions who “own” the employees. The markets fluctuated between “tight” or “soft” and leverage shifted back and forth from landlord to tenant. These 2 market participants, landlord and tenant, supply and demand, called the shots. Sure, there were other variables, the economy, other market influences and influencers. But the narrative was defined within a fairly narrow range.
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.
Ever wonder how landlords underwrite the financial risk of your lease transaction? Or, why many landlords prefer a letter of credit instead of a cash security deposit? The security deposit was originally conceived as a mechanism to help the landlord cover ancillary costs that come up during the term and/or upon lease expiration. Typically equal to 1 or 2 months of rent, it did not cover much. Then, somewhere along the way, an enterprising landlord with leverage got clever and decided to negotiate for more value in order to better cover what really happens when a tenant defaults.
Office markets are big boats. They don’t turn quickly. There’s always a delay between negative macro-economic events and declines in rental economics. After all, it’s not as if landlords see the negative event and decide it’s time to lower rents. No, they resist. As long as possible. This creates a gap between where everyone knows the market is heading and where it is otherwise defined by comparable lease data. We’ve written in the past about how eventually a declining market reaches a point of broad capitulation when landlords are more unified at the bottom – this is when nearly all tenants benefit from the down market simply by showing up. The challenge facing occupiers whom are negotiating at the front end of the downturn is how to capture the full benefit of a decline that has yet to fully mature.
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.
