A New Challenge for Business Owners
The Traditional Tenant For Major Class A Office Buildings Is Dying Out Quickly
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The office leasing industry in the U.S. has been below desirable occupancy levels for many years. Vacancy rates remain high and are still increasing in some regions, with even the most promising regions only reporting a modest improvement or flattening off of the vacancy trend. Meanwhile, vacant space continues to languish. Similarly, rents have been declining and even absorption rates, which have only recently turned positive after years of negative rates, appear to be, at best, flat again. |
The response from the tenant has been to seize upon the weakness of the market to negotiate ever more flexible terms, leading to lower income for office building owners. Leases today are very different to those signed just a few years ago and are characterized by:
- Much shorter durations, with just a few years lease now typical, compared to 10-15 years previously.
- Smaller sq ft requirements with a deal size of less than 5,000 sq ft per deal now common.
- Lower rents.
- Declining average sq ft requirements per worker.
Office building owners have had to manage lower occupancy rates and higher turnover of tenant resulting in suboptimal use of their assets.
Unfortunately, macro economic trends in place today will increase the pressure on office building returns. Respected commentators have identified a combination of factors that will conspire to make tenants demand ever more flexible terms:
- The offshoring (or outsourcing) of jobs from high cost labor markets to low cost regions. While this has been happening in manufacturing industry for many years, we are now seeing growing numbers of service jobs going overseas - jobs that would typically be done in offices in the U.S.
- Large corporations paying increasing attention to managing their real estate portfolio as a way to take out costs from their businesses. The focus is on total occupancy cost and reducing it through leveraged IT; flexible working; virtual teams; and working from home. Corporations are now seeking much more flexible terms from office building owners.
- The aging of the baby boomers. As these people get older and retire there are not enough young people entering the workforce to replace them, thus reducing demand for office space.
- Interest rates. Interest rates are now increasing leading to higher cost of capital for investors. This will lead to lower capital appreciation of office building assets and a decrease in the return on office buildings at existing income levels relative to other assets. There will thus be an increased focus on improving office building returns through rental income.
- Corporate Realities. Businesses faced with high productivity demands no longer can afford to carry employees through all business cycles. Most cycles are shorter than traditional leases meaning the people who occupied the office at the start of the lease may not be the same ones at the end of lease. To meet this reality, businesses want shorter terms and smaller offices which can be closed or moved without large obligations.
In the future, corporate tenants will want something very different. The office space of the future for most successful businesses will:
- Be pre-built in a configuration they find acceptable and where they can move in quickly
This means the building must offer a number of size and configuration alternatives which are "turn-key". - Require that administrative and facilities support services be included
Corporations don't want the obligations of staff not directly related to their core business operations but need services such as reception, package handling, facilities administration, etc. - Lease space in small modules rather than large blocks
They now structure offices by market size or on a project basis, both of which are constantly changing. They will not lease a large block filling it occasionally, but also often paying for space they are not using to capacity. Instead, they may rent a very small "core" space and expand or contract other space as needed. - Expect expanded serviced amenities
Businesses will always need serviced amenities such as conference rooms; pantries; reception areas; storage; etc. But it's not enough to just have these amenities available, they also want someone to set it up; service it; support it and more throughout the day. In short, they want service dedicated to them. - Not sign leases for more than one or two years
Nor do they want complex leases with creative escalation formulas which must be negotiated extensively for each location. Instead, they look increasingly toward office locations where they have simplified lease terms and possibly even pre-signed leases to speed the startup.
Smart Landlords are not ignoring these trends waiting for the "glory days" to return. They will not return. Some have even tried opening their own office business centers, but most have turned away from the high service component and given up. Now, there's a solution for all owners of profile office buildings to profit from the above long term trends by appealing to the new, flexible corporate tenants: Locartis Business Center Services
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