Today is not the best time to be a commercial landlord. Or a tenant, actually.
Smaller footprints, shorter terms, mismatched tenant improvement costs, and workforce mobiity demands are breaking traditional leasing models. How did this happen, and what will change?
How did this happen?
Employees need less physical space to do their work. Support functions have shrunk even more. Acceptance of a “sharing economy” means turf ownership does not signify value the way it used to do. And a technical ability to work from anywhere allows high productivity with fewer seats on-site.
Add volatility, uncertainty, and rapid social change. The risk of too much space dwarfs the potential benefits of stability. So lease terms are shorter.
With a smaller footprint and shorter terms, tenant improvement (TI) funding goes way down, well below tenant’s actual capital costs. For landlords, shorter lease terms translate to lower property asset value, which increases borrowing costs to fund even reduced TI’s.
It gets worse. Theoretically, the TI allowance for a ten-year term on a smaller footprint should cover design and construction of the reduced area. In fact, it does not. High-finish areas like reception, conference, and café represent a greater proportion of total lease area, resulting in a higher net cost per square foot, and higher out-of-pocket capital expense obligation for the tenant.
We conclude that traditional office leasing is unsustainably expensive and risky, for both landlords and tenants.
What will change?
An organic solution is evolving out of necessity. . . . . Unbundle the office lease into three separate transactions:
Long-term lease for core square footage only; conference, operations infrastructure, executive leadership. Building systems improvements covered by landlord under terms of lease.
Capital improvements financing by Tenant to optimize terms.
Landlord and Tenant manage volatility with office sharing solutions; (a) co-working space in building managed by landlord, (b) sublease-ready co-working modules within tenant envelope, (c) off-site co-working space
Implicit in these trends is a transformation that affects the entire industry; landlords, tenants, brokers, base-building architects, interior designers, bankers, lawyers, and employees.
Shared office space will become a new service/profit center with a battle to see who ends up in control
Base building core design will support higher density and greater multi-tenant flexibility
Shared office floor(s) will be incorporated in most office buildings
Menu-based broker fees will cover a wider range of services delivered through more and smaller transactions
Interior design will become even more generic, "portable", furniture-driven
BOMA load factors will lose their historic meaning as an efficiency metric (rentable:usable ratio)
Lease documents will address a moving target of flex options, amenity access rights, and pass-through expense formulae
Commercial loan structures will support new tenant capital expense obligations
If you’re like many of our clients, you’ve already seen these trends emerging. We’d welcome your stories and questions.