There’s no doubt that COVID-19 has altered the market for workspace as it has introduced economic uncertainty and forced companies to employ remote working strategies. As COVID vaccine rollouts are planned, the overriding question is whether working from home will remain a temporary solution or change to a permanent one. Consequently, the immediate problem is how to deal with the current, fraught marketplace. Everyone seems to a have a theory about what’s going on and what should be done.
Grant Pruitt, SIOR, president and managing director of Whitebox Real Estate in Dallas, has a nagging suspicion that most companies are making the wrong decision based on short-term thinking, while big tech will do well because executives of these firms are thinking long-term.
“I tell everyone the deals people don’t seem to be talking enough about were done by Facebook, Amazon, and Google,” Pruitt says. “And we are talking about office space. Amazon is taking millions of square feet across the United States, including 100,000-square-feet in the Dallas-Fort Worth (DFW) area, which will bring them to 220,000 square feet. Facebook leased 730,000 square feet in midtown Manhattan and Google leased 800,000 square feet in downtown San Francisco.”
The importance of these deals, Pruitt avers, is that the tech companies he mentioned will have a leg-up when competing for talent. “These deals done in the heart of 2020 were fabulous plays because if you look at San Francisco and Manhattan, those are 12-month installs. These offices will open in summer 2021 and will be beautiful, safe, designed for social distancing, and comfortable for working. These companies will crush the competition in attracting talent.”
Pruitt’s 3 Tips for brokers:
- Landlords that will win over the long-term are engaging with tenants today. In the middle of COVID, we went to a landlord and asked if he would negotiate with a tenant, who was considered downsizing. The landlord was rude and unwilling to compromise. Six months later, the client needed three times as much space. That landlord was not going to get the client’s business.
- Termination options. Landlords balk because banks don’t like it. However, tenants very rarely exercise tenant options. It’s a good way for landlords to get a longer-term deal, guessing full well the tenant will continue on.
- Start having conversations today about taking more space.
The problem with short-term versus long-term leases is more of an issue with the smaller high-tech companies and that was happening before COVID, says Kim Ford, SIOR, CEO of Rise Pittsburgh. “The trend line was there but COVID shot it up to the stratosphere like a rocket ship. COVID solidified the fact that landlords have to be more flexible so tenants have a chance to be successful.”
Ford does a lot of work with robotics and the autonomous car industry. One company she worked with moved seven times in two years. In just a few years, another start-up signed a 10-year lease for over 100,000 square feet, which was double its prior space.
These tenants and many other technology companies are selecting buildings which are now being called tech-flex space, which is typically traditional flex space in a great location, close to universities with higher ceilings.
Ford was able to do this kind of deal because she had been working with this particular company since it was a start-up. “Early stage, seed, or Series-A companies are the majority of the tech sector market and these firms can’t do long-term deals because growth is unpredictable, which is why one to three years are optimal,” she says. “These companies with 10 to 50 workers are 70% to 80% of our market.”
Ford’s 3 tips for brokers:
- Work with your client’s board of directors to determine what the long-term goals are for the company. Help them achieve their goals. Many brokers don’t care - they just want to get a deal done.
- Based on the goals, build in as much flexibility as possible into leases. Again, many brokers do a deal and then hope to get a call in two-years. It’s better to aid the company in their future successes and continue the relationship.
- Make sure the location is right for the goals. Sometimes it’s not about where the leadership is located, but where the primary workforce is located. Locate where the talent is in order to recruit the top talent.
Back in March 2020, Randy Mason, SIOR, partner for Commercial Realty Specialists in Orange County, Calif., was in the middle of negotiations for a client to renew a lease when COVID washed over the world. The client, understandably uneasy, signed a six-month extension to see if the world would end. The client was in two suites in the one building and, like everyone else, sent most of the staff to work remotely. When the extension was nearing an end, the thought was that the client would downsize and give up one suite, which would leave it short of space, so they were thinking of adding more space to the remaining suite. Doing that would cost $170,000, which meant the landlord needed a longer lease. The client wanted five years, the landlord seven, and the compromise was six with the landlord throwing in substantial tenant improvement and other incentives.
Mason’s 3 tips for brokers:
- To keep nervous tenants or those considering move-outs in the current environment for a longer term, landlords must be generous. Consider: tenant improvements, free parking, parking validations, and various rent concessions (free rent at the back end if the lease is not cancelled.)
- Even though a vaccine is available, it may take two years for the market to sort itself out. Begrudgingly, the landlord may need to resort to short-term extensions, i.e., one year, to keep the cash flow going.
- Consider all outcomes of subleasing. When a tenant wants out and the recommendation is to sublease instead, That may not be a practical solution due to a competitive marketplace, resulting in a lower rental rate received by the subtenant than current contractual rent (the sub-lesser would have to make up the difference); becoming a landlord; and inheriting the risk if the subtenant moves out before the end of contract (lease still in place and payment returns to you).
“Companies are asking, regardless of what happens with COVID, what is my future model going to look like? Because working from home is at least a desirable part of working time. How do I accommodate that?” questions Andrew Cheney, SIOR, principal with Lee & Associates in Phoenix.
The tech world is over-reacting to working from home, Cheney adds. After talking to brokers who work the tech corridor between Scottsdale and Tempe, Cheney saw that some companies weren’t going to renew leases, but at the same time weren’t going to lay-off anyone and going full-bore working remotely. “That is a mistake,” Cheney notes, and echoing Pruitt, he concludes, “These companies are going to regret that, but for now that is the thinking in part of the tech world.”
As for landlords, they are now making paper airplanes out of their pro formas because they have no idea what is going to happen.
As for landlords, they “are now making paper airplanes out of their pro formas because they have no idea what is going to happen,” Cheney jokes. “Any typical landlord is just trying to get occupancy. Any deal that makes sense is a good deal.”
Cheney’s 3 tips for brokers:
- Now’s the time to review basic blocking and tackling. Do a marketing audit because sites like CoStar and LoopNet generally have wrong or outdated information. Update marketing photos, etc. Control at least how your project is positioned in the marketplace with the basics.
- Landlords need to get proactive with tenants. Start discussions about early renewal.
- COVID may disappear with the coming of the vaccines. However, in the meantime tenants are going to want anti-virus security.
That goes for tenants as well. Cheney recently concluded a deal in the Phoenix metro for a bridge engineering company taking 10,000 square feet. Originally, the deal was going to be for 12,000 square feet, then the company decided it would be “hoteling” and desk sharing, and didn’t need so much space. The landlord offered big tenant improvements (TIs) in exchange for a longer-lease. The question for the engineering firm was, did it want short-term flexibility or the expensive TIs. It opted for the latter and the landlord got in return a seven-year lease.
OTHER PERSPECTIVESNON-BROKER ALTERNATIVE SUGGESTIONS
Mynt Systems of Santa Cruz, Calif., SIOR affiliate member, calls itself a building performance firm with a focus on zero-net-energy retrofit projects, and when considering strategies to create long-term tenant commitments in a short-term climate, it fosters an alternative concept.
“We are more of a property performance partner, so I get to hear all the ins and outs of what is going on in the market,” says Derek Hansen, CEO. “We get to see behind the curtain and what we see is a lot of insecurity. Not just with COVID but with a new political administration. We see tenants looking to hedge against an unstable future.”
It may not be the same in other states, but one of the quickest rising costs for California industrial tenants is the cost of power. What Mynt has been doing is retrofitting existing buildings to bring down energy costs for the tenant. In return, the landlord asks for longer-term commitments.
For example, Mynt worked with the owner of an industrial building in Fremont, Calif., which had as a tenant a computer chip manufacturer. The company was growing, adding new shifts, but the cost of power kept increasing, so it was actually losing profitability. Mynt created a high-efficiency, high-performance renewable energy system including solar power with 100% offset.
“What ended up happening was, the owner created a lease addendum, which stated this is what the tenant was paying the utility company every year. Now, the tenant would pay the landlord 80% of that expense. The tenant would get a slight increase in rent, but energy costs would be flat-lined (no increase). The landlord got another 10-years on the lease.CANADA
Like a few American cities, Canada, as an entirety, is at the more extreme end of the lock-down spectrum. It’s even more absolute in Ottawa, the capital city, as the Canadian federal government is mostly working remotely.
“The effect has been to shake-up the whole leasing system,” says Alan Doak, SIOR, a principal with Proveras Commercial Realty in Ottawa. “People are questioning if companies will use offices in the same way when COVID is done. Many progressive companies had already been doing some form of remote working and now people are comfortable managing staff on a remote basis.
Proveras concluded a couple of 65,000-square-foot transactions during the heart of the COVID crisis, although Doak adds, most tenants are pausing as to what to do next, waiting to do meaningful exploration as to whether working remotely is efficient.
Doak offers three suggestions for brokers in the current market, one or two of which are surprisingly counterintuitive.
1) Tenants and landlords need to be flexible and creative. For example, if the landlord has 25,000 square-feet available and is talking with a prospective tenant that is not sure it would use all the space, it would be best to compromise, i.e., not erect a demising wall and give the tenant a two-year option to decide about the extra space. Let the tenant feel it has flexibility in regard to its future.
2) If there is a contractual economic penalty when a tenant leaves before a set termination period, the landlord should not use the revenue to bulk up coffers. Instead, those monies should be used to subsidize new deals or upgrade buildings to be more attractive to potential tenants.
3) Now that a vaccine has arrived, over time, tenants will not be so concerned if the building is COVID safe. This is something that will go away. If air filtration system upgrades make sense for the long-term, then do it. If it specifically relates to the control of viruses like COVID, I would stay away from anything that is too expensive.
This article was sponsored by the SIOR Foundation - Promoting and sponsoring initiatives that educate, enhance, and expand the commercial real estate community. The SIOR Foundation is a 501(c)(3) not-forprofit organization. All contributions are tax deductible to the extent of the law.
Andrew Cheney, SIOR
Alan Doak, SIOR
Kim Ford, SIOR
Derek Hansen, CEO of Mynt Systems, General Affiliate
Randy Mason, SIOR
Grant Pruitt, SIOR