Renovate America’s headquarters at 16409 W. Bernardo Dr. in the Rancho Vista Corporate Center in San Diego were recently renovated by Pacific Building Group. | Courtesy a representative of Pacific Building Group

Roundtable – September 2018: How are corporations’ views on real estate leasing changing?

Carrie Rossenfeld Roundtable

From SoCal Real Estate’s September 2018 issue:

Jim Proehl, president, Western Division,
PMRG | Courtesy a representative of PMRG

Corporate America has realized the key to attracting and retaining the best and brightest was in matching the office environment to the views of the new millennial workforce.

Rent associated with office space is no longer viewed as an expense line item to be controlled and kept to a minimum. It is now viewed as a key recruiting tool to attract and retain the most talented employees. The result has been a dramatic shift in how much corporations are willing to pay in rent to build-out showcase office space in premium locations with the most amenities. Top companies are now willing to spend $100, $150 or even $200 per square foot to build out creative-office space with all the bells and whistles expected by today’s young professionals. The largest companies include these amenities when building out their office space, while smaller companies base lease decisions on which properties can provide the most amenity-rich environment, either on site or within walking distance. With the majority of tenants in Southern California occupying less than 5,000 square feet, property owners are laser-focused on amenities that provide competitive advantage in the market. Although many companies will not relocate outside of a certain submarket, they will move to a property within the submarket that offers more amenities for their employees.

Fitness and conference facilities are no longer an afterthought for most owners. They are a sales tool to attract companies looking for amenities that they cannot afford to provide within their space. An owner’s cost to provide the amenities required by tenants has resulted in increased rental rates and increased load factors for buildings. Common tenant facilities such as conference centers, break areas, and gyms are now included in the load factors for buildings, and the costs to operate and maintain these facilities increase the operating costs of the buildings. The increase in tenant improvement dollars required to build out these spaces results in owners requiring longer-term leases of seven to 10 years to amortize the additional tenant improvement costs, and in some cases, tenants are required to contribute some of their own capital to build out their space.

The change in tenants’ expectations has resulted in new projects incorporating some outstanding amenities and increased demand for mixed-use projects. Buyers of current projects are typically underwriting substantial capital improvement dollars in addition to 50 percent more tenant-improvement dollars. These capital commitments require new owners to continue to push rental rates higher, resulting in increases to the value of most office projects. We are approaching a point where many of the best-located office projects’ market value is approaching replacement costs.

George Crawford, senior associate,
Charles Dunn Company | Courtesy a representative of Charles Dunn Company

Corporate owners of office buildings are adjusting their strategies for leasing space. The shift is a move toward the speculative construction of tenant improvements or “spec suites” and away from the option for a custom build-to-suit. Additionally, a higher priority is being placed on tenant amenities, such as swanky zen-like lounges for relaxation and entertainment. In studying market trends, landlords have embraced the guiding principles of today’s workforce that have emerged as predictors of what office tenants want in their office environment: collaboration and wellness. These concepts have been well proven with the success of co-working operators, and now building owners want to incorporate some of those concepts into the design/re-design of their buildings.

The most compelling reason causing landlords to speculatively construct tenant spaces is the effect is has on leasing time. This strategy removes a huge deal-killing problem experienced in the leasing process: decision paralysis. When given a choice between two spaces, all things being equal, tenants will always choose the space with the easiest path to taking occupancy and opening for business. In today’s tech-driven workforce, where everyone is constantly connected and never truly separated from the demands of work, tenants do not want the unnecessary barriers of traditional leasing, which generally include: talking with an architect to discuss the placement of the offices, reviewing and revising a space plan, waiting for TI pricing from the contractor, and then waiting for the build-out to complete with their continued monitoring and oversight. Ultimately, today’s successful landlords understand that the traditional barriers of leasing need to be removed.

From the landlord’s perspective, collaborative space is a design concept that is relatively simple to template and reproduce. A typical collaborative office space incorporates a majority of open areas where furniture can be arranged based on the tenant’s need, a couple of offices for private conversations or meetings, a kitchen area/wet bar, and modern architectural elements such as exposed ceilings. In the world of Title 24 and other factors adding to the cost of tenant improvements, the spec suite enables the landlord to predetermine construction costs, reduce design costs, and forecast future income more accurately. Also, instead of allowing a tenant to over-customize a space only to demolish it a few years later and start over, the landlord can now design spaces that will hold residual value for future tenants.

What was once viewed as a gamble — making an up-front investment in vacant office suites — is no longer seen that way. The market has spoken and approved, and it has now become the new normal for many owners and users. And, in a tech-driven world where everything is instant, the office leasing model fits right into this new work paradigm.

Ben Gott, co-founder and managing director,
Redwood West | Courtesy a representative of Redwood West

In today’s business climate, two critical areas to change management are both human capital and company culture. Competing for top talent and instilling a company culture that empowers its employees are two major challenges for every company. Corporate real estate happens to be one of the major common denominators between these two challenges. Companies today utilize their place of business as a recruiting showpiece and retention mechanism for top talent, as well as a visual representation of the culture.

Engaging top talent and maintaining a strong corporate culture can be costly. Since resources are not infinite, the great balancing act for members of the C-suite, and/or corporate real estate professionals within those organizations, is to maximize the efficiency of those dollars spent vis-à-vis acquiring top talent, increasing overall employee productivity, and maintaining / creating a culture whereby employees are proud and happy to come to work.

As the Dow dipped below 7300 in 2009 and the unemployment rate doubled to 10 percent in two short years, many companies were ultimately forced to do more with less in order to survive. Since that point, this mindset has stuck in American business. In an effort to stretch every dollar, employees are asked to go the extra mile. Human nature, however, does not always cooperate. If employees feel appreciated and can thrive in their work surroundings, more often than not they will go above and beyond. Creating workplaces that are people orientated, experiential, and personalized requires a financial investment. As such, we see our customers looking to lease space that is more efficient with less building common areas, column free offices, and amenity-rich work environments. Overall workplace strategy helps companies to better utilize their offices and to achieve greater efficiency within the work setting.

Another unique change in corporations’ views on real estate leasing is that today’s mobile world has caused a decline in the use of overall office space. When your “office” can be your local coffee house, a hotel lobby, or your vehicle, it makes the case for corporations to question whether specific segments of its workforce really need a dedicated workspace 100 percent of the time. Maximizing the use of each square foot leased will increase profitability and create measurable P&L impact.

Gone are the days of 200 square feet to 250 square feet per person. With mass transit and Uber, the requirement for parking and overall footage demands is forever gone. From a real estate perspective, Corporate America is focused on profitability. Dynamic, experiential work places that strengthen recruiting efforts and employee morale are a major focus for corporations as they lease office space. Corporations want their leased spaces to be an asset to their business (no longer just a P&L liability) by immersing their employees in the culture and giving all team members an enjoyable environment in which to work and play.