April 14, 2020

After Covid-19 - Will Office Leasing Ever be the Same?

Most of the CRE professionals I talk to are naturally really worried about what the COVID crisis is doing to the office leasing business. They’re concerns all seem to revolve around three points:

  • Can I retain my good tenants? The ones with healthy balance sheets and good chances for survival by blending and extending their leases? How much rent do I need to forgive and how many additional years of term can I get?
  • How can I continue to generate interest during the lock-down for firms that still need space?
  • How long will it be until new tenants return en masse to the leasing market after the economy restarts and what will lease terms need to look like? Will it be 3 months? Six? Or will it take a full year? Will I need to offer shorter terms? Larger tenant improvement allowances? Lower rates? More abatement? [hint: yes, yes, yes and yes.]

This perspective makes sense given the ‘black swan’ nature of what’s happened to the economy and our industry. Everyone is still trying to sort things out and make sense of things in the here and now - we haven’t really had time to think about what might be different on the other side of the crisis. 

But the nagging question we’ve got to get around to is, will things ever return to ‘normal’ in commercial office leasing? Or will the way companies think about how they run their businesses and the workspaces they need be forever changed?

Our earliest investor, Mike Maples from Floodgate, has a term for events that cause consumers or business or society at large to re-think things that had been taken for granted: he calls these belief inflections. And I’m pretty sure a year or two from now we’ll look back on the Coronavirus as one big belief inflection in how companies think about office space.

Economic crises create lots of belief inflections. Just think back to the great recession of 2008 and how people thought about:

  • Renting space in private homes to help homeowners cover their mortgages and strapped consumers save money on hotels was a belief inflection that created AirBnB
  • Owning a second or in some cases even a primary car in urban areas when you can pay someone else that owns one to drive you to and from your appointments was a belief inflection that created Uber and Lyft
  • Finding a professional office to work in once you got laid off and found yourself an involuntary freelancer was a belief inflection that created WeWork.

Sadly the new version of ‘the office’ - what I call Office 2.0 - was born out of the last economic crisis and it is very likely to get crushed by this most recent crisis. It provided freelancers and small startups that needed access to workspace a solution based on highly dense, shared workspaces that you could sign up to use for a few months or a year or two. Because these spaces could pack lots of people into a shared space - average density of less than 100 square feet per person versus the nearly 200 of a traditional office - coworking operators were able to make a profit spread over what they paid landlords to lease the space.

But just like other retail consumer businesses like bars and restaurants, retail coworking operators see their profits turned into mountains of losses when the members opt out of their short-term memberships. Without a mountain of cash to buffer the losses until their occupancy returns to 85% or more many of these operators will cease to exist in their current form. 

One result will be that many landlords are going to get coworking spaces back from operators that simply default on their leases and will need to figure out how to lease it and start generating rental income from it. 

Three forces are building for yet another belief inflection around office space which point towards Office 3.0:

  • Landlords with too much empty space on their hands and not enough long-term credit tenants to lease it for 10 years at a time
  • Changed attitudes about working every day in super-dense shared workspaces after an extended period of social distancing
  • A realization for small and large companies alike that remote work really can and does work if supported by the right practices and technologies

Here is one quote from a tech CEO I got recently to illustrate this new thinking:

“I was about to go office shopping in mid-March. Obviously paused. Now that we are working remote I plan to continue to do so BUT I’d like a way to ‘shop’ for offices with a) flexible days, b) meeting rooms for ‘all hands’, c) flexible terms.  I’ll want an office for client and team meetings and some office days to order lunch but I won’t ever want 5-day/week space.“

Here is another illustration of Office 3.0 thinking from Chad Jewell, a veteran tenant broker here in Austin:

“The percentage of a traditional office user's employees who are allowed to work remotely (part-time or permanently) is going to shoot through the roof! This will also speed up hiring when geography is no longer a limiting factor for staffing up.”

These changed attitudes will not be just for the small tech startups that had adopted remote work prior to this event. There are thousands of larger businesses that were certain they could not leverage remote work to any significant degree that are going to come out of this with a changed view. This will lead them to question how much office space they will need and when/how they decide to open up satellite offices. Landlords will need to slice up their square footage in new ways to meet that change in demand as well.

I don’t know exactly what Office 3.0 will look like but I think this is not too far off. But I’m sure it’s coming and that landlords are not ready for it. The landlords that realize this new reality and adapt their leasing models accordingly will profit while others lose out on a whole new generation of tenants and premium incomes. 

Continue reading

Subscribe to Modern Work

Stay on top of the latest trends in digital leasing!
No spam!