March 2022 is expected to mark a massive office comeback, boosting the recovery of a sector that lagged behind other commercial real estate properties during the pandemic. However, there is a huge elephant in the room: pre-pandemic leases may not adequately reflect the needs of many businesses across the country.
Some companies have switched completely over to remote work, like technology talent marketplace Andela. Others have made a permanent commitment to flexible schedules and hybrid work. For example, biopharmaceutical company Sage Therapeutics found only about 5% of its employees wanted to return to the office four or more days a week. The company then switched to a work-from-anywhere model with optional office space. Others, like turntable maker Victrola, relocated headquarters to a new city.
Many companies are in the process of re-assessing their office needs, and those who are near the end of their pre-pandemic leases have access to the most options. Here are five approaches to today’s commercial real estate market.
1. Switching to Hybrid Work and Downsizing
While it may be tempting to return to offices as soon as possible, experts suggest avoiding a rapid transition. Having your team working from home at least partially buys you more time to find the most suitable option, especially if you’re near the end of your lease. Michael Cantor, a founding principal at Ohio-based Allegro Real Estate Brokers & Advisors, cites an example from his practice. One of his clients, a global management consulting company, allowed its leases in the most expensive locations around the world to expire, waiting until the dust settles before renting new office spaces.
Remote work also helps in negotiations with the current landlord. “I did a transaction for headquarters, where their lease was expiring, without enough time to go to market and build out a new space,” continues Cantor. “We informed their current landlord that they’re able to close the office and have people work from home. So it created leverage: The tenant negotiated a lease restructure with their current landlord — they downsized and stayed in the existing building, getting a better deal with more free rent, tenant improvements and lower price per square foot.”
Downsizing is a common approach among law firms. In the previous quarter, these companies signed new leases for 44% fewer square feet of Manhattan office space than the average in the two years before the pandemic. A significant part of law firms’ operations involves document review — a process that requires limited in-person communication. Pre-pandemic, cybersecurity concerns were one reason law firms required their employees to come to the office. Now, when software solutions have been adjusted and more widely adopted at employees’ home offices, law firms may not need to have all of their workforce co-located daily.
However, downsizing may not be the best approach for every type of company. According to Cantor, accounting firms, in turn, may be more interested in free address or hot-desking, flexible arrangements where employees use same-day reservations for an office spot depending on their current needs. Therefore, some companies may discover that co-working spaces meet their needs better than traditional offices, even in the post-pandemic, hybrid world.
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2. Looking for a Top-tier Office Building
A closer look at leasing activities reveals that vacancy rates significantly vary between different types of properties. The pandemic has made successful companies picky: Those willing to sign a new lease don’t want the cheapest place. They want the best, class A buildings.
For companies with leases that have just expired or are nearing a close, a renovated or brand-new office presents an appealing option.
“In New York, Hudson Yards, One Vanderbilt in Midtown, East of the World Trade Center properties in Lower Manhattan are dominating leasing activity in the office sector,” says Sam Chandan, director of real estate programs at New York University’s Stern School of Business. “These relatively newer assets are better suited to meeting health and well-being needs. They are more easily adapted to changing expectations. They come with the bundles of services and amenities, whether that be better air filtration systems or green, sustainable smart building technologies or the availability of outdoor spaces.”
High-quality, modern buildings are high on the list for IT companies that performed well financially over the pandemic. Notable deals signed by tech giants in fall 2021 signaled that offices would not disappear in the post-pandemic world. In March 2022, this industry is one of the first to push for a comeback. Google, for example, has already announced that its employees will be working three days a week from the office starting April 4.
However, while the rents have been going up in the past several months, they are still far from pre-pandemic highs. Market players don’t expect that landlords will be able to charge those rates anytime soon, allowing businesses previously located in older, class B and class C buildings to upgrade the quality of their office spaces.
3. Relocating the Office
While renovated, best-in-class buildings are popular, many urban centers that were the most desirable locations before the pandemic have limited modern commercial real estate. Some market players advise broadening the search and relocating if a company’s lease is coming to a close.
“Where are employees going to have a great quality of life? Where are their kids going to get a quality education? Ironically, it’s the less expensive places that are providing the answers,” says Catalano. “It’s a win-win. Companies pay the same payroll dollars, rents are cheaper, taxes are lower and employees are happier because they also save in many ways — housing, gas prices, etc. And you still can hire from anywhere to work remotely!”
In addition to New York, market players also name California as one of the localities that may see such an exodus: at least 74 technology companies moved out of that state last year due to a rising cost of living.
However, make relocation decisions with care: urban settings still provide the best fundraising and networking opportunities. Thus, there is no consensus on how widespread the exodus from major cities will be.
“Startups are at odds with the anecdotal evidence,” says Chandan. “Americans are less likely to relocate than before the pandemic.”
4. Subletting or Negotiating a Buyout
Unlike the Great Recession, the pandemic didn’t lead to a massive wave of defaults on office buildings. Businesses were able to adjust quickly and maintain their profitability. Further, pandemics were not specifically mentioned in leases’ force majeure clauses. Companies were not able to easily terminate their leases without penalties and continued to pay for the spaces they have been barely using since March 2020.
“Even though the utilization rate of office spaces has been lower during the pandemic, rents are still getting paid, building owners make their mortgage payments and the revenue from the tenancy is still there,” Chandan says.
For companies locked into a pre-pandemic lease, one standard approach is subletting. As companies continue to return to offices, it is much easier to find a firm that would be interested in this temporary arrangement.
Nevertheless, commercial tenants typically face numerous restrictions on what kinds of businesses can operate at a given property, if allowed to sublease it at all. Thus, some companies may find themselves on the lookout for a more optimal solution.
“There is no such thing to break your commercial lease, but you can negotiate a buyout,” explains Catalano. According to him, in the last years of the lease, landlords are more likely to accept an amount that is less than the initially expected income, but only if vacancy rates decrease.
“When landlords are confident that they can re-rent the space in a reasonable amount of time, a buyout is in their financial interest. They’re getting a lot more cash upfront,” Catalano says. “So can buyouts be the reason why some landlords reportedly still offer pretty generous concessions? Yes.”
5. Keeping and Updating Your Existing Office
Some companies, however, find themselves not being able to do much about their pre-pandemic arrangements. Most of those leases were a decade long, and negotiating a lower rate is near impossible.
“Landlords have certain restrictions in their mortgages,” reminds Cantor. “Lenders may prevent them from entering into lower rental rates than what has been projected for the loan.”
The National Association of County and City Health Officials (NACCHO) is a DC-based nonprofit advocating for local health departments. The organization signed its existing lease just a year before the pandemic. “We quickly ruled out being able to renegotiate the lease,” admits the nonprofit’s CEO Lori Freeman.
Since last July, when vaccines became widely available for all age groups, NACCHO has been trying to utilize its space at least to some degree. But, COVID transmission rates and employees’ surveys limited the number of days in the office. At present, the company has one mandatory in-person workday each week.
“I have a two-hour commute one way to the office, and I would be hypocritical if I did not say that my time at home has allowed me to be much more productive,” says Freeman. “At the same time, as a CEO, I struggle to connect with 140 staff members.”
Hoping to make a comeback more attractive to its employees, the nonprofit is asking its landlord to cover the cost of space remodeling. That includes adding private cubicles to decrease COVID-related risks. “This most likely could result in another year, or two, added on to the term of our lease,” says Freeman
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