Rent

Is Remote Work the “Netflix” for office buildings?

Jim Kramer on CNBC Squawk Box recently rhetorically asked: will this mandated “work from home” be the Netfix for office buildings as Netflix was for movie theatres?  I don’t think the analogy fits.  Pre-COVID 19, tenants were laser-focused on collaborative spaces, amenity rich buildings all to foster company culture.  I don’t see how technology can replace the human experience.  Instead, I think we’ll see more of an evolution (versus revolution) of the workspace, including work from home as part of the strategy.

As Bisnow recently reported, CoreNet Global’s April 28, 2020 survey of corporate real estate professionals found that 69% of companies are planning to reduce their office foot print after the recent forced work from home experiment. By contrast, former Google CEO Eric Schmidt on a recent “Face the Nation” interview predicts that office space will be in greater demand due to social distancing and more smaller offices in a “hub and spoke” format.  I question, will the appeal of remote work still be attractive to employees after this pandemic passes and they have a choice?  While the jury is out on the long-term implication of remote work, in this post, I address the Pro’s and Con’s and what policies companies should consider implementing to have an effective work-from-home (“WFH”) strategy. Continue reading

Filed under: Company Culture, Confidentiality, Coronavirus, Cost Savings, COVID-19, Disaster, Distraction, Employee Satisfaction, Environment, Flexibility, Health, Office Space Trends, Open Floor Plan, Pandemic, Productivity, Remote Work, Rent, Shared Office Space, Telecommuting, WFH, Work From Home, Work Life Balance, Workers' Compensation | Tagged , , , , , , , , , , , , , , , , , , , | Leave a comment

Building ServicesPre-lease Issues

The End of the Handshake Deal: Coronavirus’ Impact on Office Leasing

This global pandemic, which has wiped out the stock market and is pushing the US into a recession, will not only turn the tables in most office markets nationally, but I think it will leave an indelible mark on how companies use and lease office space once this crisis is over.  Once we have this one under control, I am sure everyone will have in mind the future risk of another pandemic.  Below is a brief outline of how I think things will change beyond avoiding handshakes. Continue reading

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Area MeasurementBuilding ServicesLease Audit

Is it Fair That My Landlord can Artificially Inflate Operating Expenses?

Most office leases allow landlords to recoup from tenants on a pro rata basis the operating expenses and taxes that the landlord pays to operate the building.  When a building is not fully occupied and where a landlord is collecting from tenants their pro rata share of expenses, a standard clause in most office leases is commonly known as the “gross-up” provision.  Essentially, it states that the landlord, from an accounting perspective, can increase the actual building operating expenses that it charges tenants to assume that the building is fully occupied.  From negotiating office leases for over 25 years and being an attorney, I find that many of our clients and their counsel scratch their heads over this provision as it seems like the landlord is trying to pull a fast one.  If structured properly, it is fair to both tenants and landlords.  In this post, I explain the reason for this provision and how tenants can best protect themselves.

The rationale underlying grossing-up expenses is that it allows the landlord to collect actual expenses which vary based upon occupancy where the building is not fully occupied.  Variable Expenses include janitorial service, utilities, and management fees.  Fixed (or non-variable) Expenses include taxes, insurance, and security.  Tenants need to be careful that the adjustment (or gross-up) applies only to variable expenses and that the landlord cannot collect more than the actual expense amount.

As illustrated below, where a landlord is allowed to gross-up variable expenses to assume full occupancy, it ensures that tenants pay their fair share of those expenses.  Otherwise, when a building is not fully occupied, tenants would be paying less than their proportionate share of expenses.

  • Building’s gross rentable area = 100,000 sf
  • Building is 50% occupied by two tenants:
    • 20% – 20,000 sf tenant
    • 30% – 30,000 sf tenant
  • Current Utility Service = $100,000
  • Grossed-up Utility Service = $200,000
  1. If Utility expenses are NOT grossed-up to assume 100% occupancy, then the Landlord cannot collect all of the Utility expenses.
    1. 20% of $100,000 = $20,000 ($1/sf for the 20K sf tenant)
    2. 30% of $100,000 = $30,000 ($1/sf for the 30K sf tenant)
    3. The landlord would only collect $50,000 of the Utility expenses which total $100,000
  2. If Utility expenses are grossed-up to assume 100% occupancy, then the Landlord can collect ALL of the Utility expenses.
    1. 20% of $200,000 = $40,000 ($2/sf for the 20K sf tenant)
    2. 30% of $200,000 = $60,000 ($2/sf for the 30K sf tenant)
    3. The landlord collects all of the Utility expenses ($100,000).

A question that comes-up occasionally is: what is “full occupancy”?  The conventional wisdom has been that a building is never 100% occupied, given the ebbs and flows of leasing, so 95% occupancy is deemed as “full occupancy”.  Recently, however, I have seen some landlords push that to 100%.  Depending upon a tenant’s size in the building, it may or may not be worth challenging the 100% assumption.

While this gross-up concept generally benefits landlords, it does benefit tenants where they have a full service (or gross) lease with a “base year” for tax and operating expenses where a building is not fully occupied.  Under a “base year”, where taxes and operating expenses are included in the rent, the tenant pays for increases in taxes and operating expenses to the extent they exceed the base year amount.

To illustrate, if the Base Year is 2020 with a 50% occupied building and the Variable Operating Expenses are $5/sf in 2020  which is not grossed-up and they increase to $8/sf in 2021, then the tenant would be responsible for the incremental $3/sf cost; however, if Base Year 2020 is grossed-up to 95% occupancy which would result in $7/sf, then the tenant is only responsible for the incremental $1/sf.  In that situation, it is to the tenant’s advantage to have the “base year” amount be as high as possible so grossing-up is to the tenant’s advantage.

It is also important to remember, as mentioned above, that the gross-up provision only applies to expenses which vary based upon occupancy.  Also, tenants should make clear that the landlord cannot collect more than the actual expense that is being grossed-up.  To ensure that the tenant is being properly charged, the tenant should negotiate into the lease an audit right which includes the ability to review the landlord’s calculations of the gross-up provision.

I hope this post brings some clarity to this often counter-intuitive lease provision.  Feel free to contact me with questions.

Filed under: Area Measurement, Building Services, Lease Audit, Other Lease Terms, Pre-lease Issues, Rent, Transparency | Tagged , , , , , , , , , , , , , | Comments Off on Is it Fair That My Landlord can Artificially Inflate Operating Expenses?

What’s Next for Co-Working After the WeWork Debacle?

Fueled by the dangerous accelerant of “Other People’s Money”, WeWork expanded rapidly across the country and worldwide.  At the beginning of the year, the company was “valued” at $47 Billion making it the most valuable startup in the country.  Reality eventually caught-up with WeWork after it shelved its IPO in September, forced out its CEO, reportedly lost $1.25 Billion in 3rd Quarter, and, according to a recent article in Business Insider, laid-off about 20% of its workforce.

In major cities like Chicago and New York, WeWork became one of the largest office tenants.  In Chicago, WeWork established themselves as the second largest tenant with just under 1M sf; that said, WeWork represents less than one percent of the Chicago CBD office market. To maintain market share, other co-working companies continued to expand albeit at a relatively slower pace.  Landlords gladly leased space to these co-working companies to fill vacancies at typically above-market rates.

As a result, while not apparent in our strong economy with unemployment at a 50+ year low, it is my opinion that co-working supply has far outpaced demand.  In a recent Wall Street Journal article, Boston Fed President, Eric Rosengren, recently warned of the risks of co-working to the commercial real estate market, (See: Boston Fed President Warns of Co-Working Risks to Property Market). It will become apparent once we have an economic slowdown in the US, as many co-working users will “return to the mother ship” (for the large corporate users who used co-working for satellite offices) or will work virtually.  As Warren Buffet famously said: “Only when the tide goes out do you discover who is swimming naked.”

The co-Working business model is simple: long-term lease of office space, build and furnish and then sublet for a premium to multiple subtenants (actually licensees).  In a September 4, 2019 interview with CNBC, real estate billionaire Sam Zell , in reference to WeWork’s planned IPO said: “Every single company in this space has gone broke.”  Sounding prescient, he went on to say: “Every other time in history when they create that, results are predictable. Why is this any different?”

Co-Working, however, is a sector that is here to stay, as I wrote about last December in my post: Is Co-Working the Right Choice for Your Business? Office Space Alternatives for Tenants Today , for 3 reasons: (1) Service, transforming office space from a product to a service; (2) Flexibility, given today’s fast changing business and product cycles; and (3) Community, fostered by sometimes complimentary businesses.  Of course, tenants pay a premium for this arrangement which is analogous to staying at a hotel for an extended period instead of renting an apartment.

While investors in co-working companies face exposure to losses, many landlords are actually on the front lines when co-working goes south.  That is due to some overly eager landlords agreeing to leases with co-working companies that leave them with little recourse in the event of a lease default.

Many co-working leases are not with the co-working company, but with a shell company (special-purpose entity “SPE”) that is created for each co-working location.  This structure is much like how building owners create SPE’s for each building to isolate liabilities.  Under this structure when a co-working site is no longer profitable or is in default, the co-working company can simply pull the plug and the co-working SPE is the entity that remains liable to the landlord, not the parent co-working company.  This could be an issue for tenants in buildings where landlords lease a significant portion of a building to a co-working company.  If the co-working company goes under, it could lead to a cash flow interruption for the building owner and possibly a default under its mortgage.

Looking ahead, I think we’re going to see landlords (and their lenders) be more conservative in underwriting leases with co-working companies.  To stave off the impact of the “WeWorks” of the world, some landlords have created their own co-working ventures, as was reported in the Wall Street Journal (See: WeWork’s Latest Threat: Old-School Landlords Trying to Copy WeWork).  Landlord, Hines Interests, recently launched its version called “Hines Squared”, with building owners such as Boston Properties and Tishman Speyer following suit.  Time will tell if they will succeed in this sector.

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Lease AuditPre-lease IssuesRent

Tenants: Are You Ready for the New Lease Accounting Standard?

2019 is a big year in lease accounting.  In 2019 (which began December 15, 2018 for fiscal year reporters), publicly traded companies are required to comply with the new accounting standard (ASC 842) and are required to recognize leases greater than 12 months on their balance sheet.  In 2021 (beginning on December 15, 2020 for fiscal year reporters), all other entities (i.e., private companies including non-profits) will be required to comply with this new standard.  Note, given the challenges facing compliance, FASB recently agreed at their July 17, 2019 meeting to extend this effective date for private companies from 2020 to 2021.  It is expected that over $2 Trillion will be transferred to US companies’ balance sheets.  As I previously wrote (Lease Accounting Change Gets the Go-Ahead ), financial transparency is the driver of this new standard which was developed in the wake of the great recession.  “We believe that this new standard is important because it will provide investors, lenders and other users of financial statements a more accurate picture of the long term financial obligations of the companies to which they provide capital,” said FASB Chairman Russell G. Golden.  Now that it is official, in this post I highlight what office tenants should be doing to comply with this new standard.  I am joined on this post by Mirela Gabrovska of MBG Consulting, a national expert in lease administration and auditing.

Continue reading

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Tenant Build-out

Is the Open Office Plan Dead?

Last year a Harvard Business School associate professor (Ethan Bernstein) led the first empirical study measuring both face-to-face and electronic interaction before and after two Fortune 500 companies moved to an open barrier-free workspace.  Contrary to conventional wisdom, the study found that, with the open workspace, personal interactions dropped approximately 70% while electronic interactions increased between 22% and 50%.  After this study was released (which some industry professionals have challenged), countless articles have been written that the open office plan is another misguided corporate management fad and the real reason for its adoption is to reduce costs by densely packing workers into a smaller space.  While there’s certainly a cost benefit to a more open plan with a smaller footprint, particularly as rents in many markets are hitting historic heights, in this post I briefly discuss how a thoughtfully-crafted open office plan can increase personal interaction and productivity while contributing to the retention and recruitment of talent. Continue reading

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Other Lease TermsSubleasing and Assignment

Is Co-Working the Right Choice for Your Business? Office Space Alternatives for Tenants Today

Co-Working companies have been big consumers of office space over the past few years.  For example, WeWork is now the largest occupier of office space in NYC leasing 5.3 million square feet. Investors are pouring billions of dollars into these companies as recently reported by the Wall Street Journal  where SoftBank Group committed an additional $3 billion to WeWork which would boost its valuation to $45 billion.  In addition to traditional office buildings, underutilized retail space is taking advantage of the trend by re-purposing empty storefronts and suburban shopping malls into co-working spaces.  Even big box office supply giant, Staples, is getting in on the game, as it contemplates closing 70+ locations. Partnering with Workbar, they are creating co-working spaces within their store that will offer high-end work spaces, meeting rooms, private areas, printers and Wi-Fi along with networking opportunities.

While the sector may have excess supply, this way of working is here to stay because it provides: (1) Service, transforming the product of office space into a “service”; (2) Flexibility, given today’s fast changing business and product cycles; and (3) Community, fostered among sometimes complimentary businesses.  For these reasons, co-working is being adopted by many Fortune 500 companies and is no longer limited to start-ups.  In this post, I address the advantages and disadvantages of co-working and what other work space options are available to tenants as landlords have recognized this shift in tenant demand.

Co-Working 

It is important first to understand the legal structure underlying a co-working arrangement.  With co-working, the co-working operator signs a long-term lease as a tenant on a large space with the building owner, where the co-working operator constructs and fully furnishes the space. Unlike a sublease where a property interest is transferred, co-working agreements are typically licensing agreements (commonly referred to as “Office Service Agreements”) with the co-working user paying a premium over the direct rent under the lease between the co-working operator and the landlord. These agreements are analogous to gym memberships or an agreement for hotel accommodations. While co-working has been around for over 20 years with shared office providers and incubators that are industry specific, over the past several years it has expanded greatly being used by start-ups to Fortune 500 companies.  Like anything, it’s not a one-size fits all office space solution.  As many co-working companies offer daily trial memberships, you may want to take one for a test drive.  Also, as these co-working companies pay brokerage fees to your agent at no added cost to you, it behooves you to have your agent include co-working options in any search for office space.

Advantages Here’s what companies find appealing about co-working spaces:

  1. Flexibility – Unlike traditional leases which are typically at least 3 years and most often longer, co-working space agreements are 12 months or less.  This is particularly advantageous to new companies where they have little visibility on the growth of their business.  It also appeals to some established companies that require a satellite office where there may be changes.
  2. Speed – Move-in ready, fully furnished.
  3. Minimize Costs – As there are typically minimal security deposits, and they can avoid the costs of furniture, office construction and take advantage  of shared amenities (i.e., office equipment, conference rooms, kitchen, etc.) while being located in a desirable building.  This is also particularly important for new companies that want to keep their capital invested in their business.
  4. Amenities – Amenities commonly found in major tech firms in Silicon Valley are commonly incorporated into co-working spaces.
  5. Community/Networking – Symbiotic environment of complementary businesses, business networking, in-house seminars (i.e., “Lunch & Learn”).
  6. National/International Access – The larger co-working companies may offer access to co-working centers in other parts of the country and/or globally for those companies that travel often.

Disadvantages – Companies find the following trade-offs with co-working spaces:

  1. Higher Costs – The advantage of flexibility and a fully furnished space comes at a premium. Think of a hotel, while it has all of the conveniences, to reside there full time is expensive.  This is particularly evident when your business needs space for more than 10 or so employees, depending upon the market.
  2. How Much Space am I Getting? – Unlike a traditional office lease or sublease where the size of the space is a key term, in co-working arrangements, what is listed as a private office or work space is typically not defined in square feet. As co-working operators are looking to maximize the density of the overall space, most co-working private offices and work spaces are much smaller than what you’d typically find in a traditional or private office.  For example, I recently reviewed one co-working space where a 150 sf office was designed to house 5 people where the monthly cost was nearly 5 times the rent for direct space in the building.  While that includes use of shared amenities and areas, that remains a large premium.  For some businesses, the premium is worth it in terms of timing, flexibility and community.  In exploring co-working spaces, be sure you compare “apples to apples” by examining the size of the work space you’ll be working in.
  3. Distractions & Lack of Privacy and Security  – Relative to the dense nature of the space and co-habitating with other businesses, there is less privacy, which can be an issue for companies handing confidential information (i.e., lawyers). Security is also a concern that must be addressed as to data, physical assets as well as confidential documents. There are also the distractions caused by noise from others which can be amplified if the space was not built with acoustics in mind.  To create a sanctuary from the noise, “privacy pods” have been created which are in very high demand, with some co-workers waiting 30 minutes to use them to make a confidential phone call as was recently reported in The Wall Street Journal – “The Best Spot in the Office Is a Phone Booth – If You Can Get Into One” 
  4. Lack of Identity or Brand – In a shared space, there is a challenge to create your brand and identity in the space.
  5. Work Hours May be Limited – Particularly as a start-up, you’re working long hours; however, some co-working spaces have limited business hours (i.e., 8 am – 5 pm, weekdays).
  6. Little Room to Negotiate – Unlike an office lease or sublease, the co-working agreements are not very negotiable.  While they are short-term, you should carefully review them with your tenant adviser and attorney.  Be careful as some of these agreements have automatic renewal periods.

Subleases

Unlike co-working agreements, subleases involve a transfer of a property interest. It is important to note that a sublease is actually a 3-party agreement among landlord (master landlord), tenant (master tenant/sub-landlord) and subtenant.  As a middle ground, businesses should explore subleases which offer some of the advantages of co-working without some of the disadvantages.  Subleases, however, are not without their trade-offs.

Advantages – Here’s what companies find appealing about sublease spaces:

  1. Flexibility – Typically a sublease is a shorter term, however, there are some longer subleases in the market which will be similar to a direct lease.
  2. Speed – Commonly move-in ready and fully furnished.
  3. Lower Costs & Capital Expenditures – Many times subleases are furnished and fully constructed with minimal (if any) security deposit. Depending upon market conditions, rents are usually discounted from the rate under the prime lease between landlord and tenant.
  4. Create your Brand – As this is a company’s private space, you can create your own identity subject to the terms of the sublease which may require consent of the sub-landlord and/or master landlord.
  5. Privacy – Since you are not sharing space with other companies (unless the sub-landlord retains a portion of the space for its use), privacy is assured as is the lack of external distractions.
  6. 24/7 Access – As is typical in most office leases, if you need to burn the midnight oil, they can do so 24/7.

Disadvantages  Here are the challenges of subleases:

  1. Needle in a Haystack – The space may not align with all of a company’s space requirements, so you may need to be open-minded
  2.  Subordinate – No direct landlord relationship as subtenant is subordinate to master tenant. If master lease is terminated, then so is the sublease. See my blog post Subtenant’s Guide to a Great Deal.
  3. Lack of Community & Networking – Other than networking with fellow tenants in the building, there are fewer opportunities for internal networking; however, subtenants, in creating their own brand, are also creating their own sense of community.
  4. Lack of Amenities – Unless the building offers the amenities in its tenant lounge and building fitness center, you may not have access to the rich amenities found in co-working spaces which help in hiring and retaining employees. Note, in highly competitive office markets, landlords are in an “amenities arms race” – see my post Office Building Amenities Arms Race.
  5. 3-Party Dance – With the added layer of negotiating with the landlord to consent to the sublease, and with the landlord collecting rent from the existing tenant (sub-landlord), the landlord does not share the same level of motivation to finalize a deal, so it can become a slow 3-party dance

Direct Space – “Spec Suites”

In today’s competitive leasing environment and seeing the strong demand in co-working spaces, landlords are pre-building and furnishing offices (from small suites to full floors). These are commonly referred to as “Spec Suites”.

Advantages – It shares all of the advantages of subleasing; however, rents are not discounted and lease security is of greater importance.  Unlike subleasing, the company has a direct relationship with the landlord.

Disadvantages – Here are the challenges of a Direct Space Spec Suite:

  1. Cost – Rent is not discounted as you’d typically find with a sublease. Also, landlords will look for security for the lease in terms of a cash deposit, but more likely a letter of credit. See my post on what tenants should consider with letters of credit Tenant Lease Security Strategies.
  2. Longer Term – Landlords are typically looking for at least 3 – 5 years of term given their investment in the space.
  3. Limited Voice in Construction & Furnishing of Space – As landlords typically have plans and furnishings already specified to meet their budget, tenants typically have less latitude to make changes.
  4. Lack of Community & Networking – See above.
  5. Lack of Amenities – See above.

Direct Space – Build to Suit

This could range from re-using a previously occupied space to choosing a raw space that will require a complete build-out.

AdvantagesIt shares all of the advantages of Subleasing; however, as is the case with Direct Space Spec Suites, rents are not discounted and lease security deposit is of greater importance.  Unlike Spec Suites, the tenant can customize the space to suit its needs.

Disadvantages – it shares all of the disadvantages of Direct Spec Suites, excluding limitations on customizing the construction and furnishings of the space.

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Building ServicesOther Lease TermsPre-lease Issues

Can You Hear Me Now? What Tenants Must Know About Office Building Cell Service

We’ve all struggled with poor cell phone service in large buildings, frequently with our face pressed to the window trying to catch a bar.  The service issue typically isn’t with the carrier, but with the obstructions within a building or neighboring buildings.  Given today’s mobile workforce where we’re using our devices for a lot more than making calls, tenants should consider this issue before renewing a lease or looking for new space. Forward thinking landlords are also concerned about this issue as they know it will affect the value of their property, which is based upon a well-occupied building.  In this post, I outline the trends behind the increasing demand of cell service, its impact to tenants, how some landlords are addressing this issue and what tenants should be doing.  Continue reading

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Pre-lease IssuesTenant Build-out

Tenant’s Guide to Minimizing Office Construction Costs

As the economy continues to expand (along with office tenants), office construction costs continue to climb.  That’s due in large part to the strong economy as well as a shortage in construction labor and certain materials. In this post, I outline strategies for tenants to minimize their office construction costs.  Thank you to Bill Conopeotis and Liz McCleary of ConopCo Project Management for their input on this post as well our long-time client Erik. Continue reading

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Pre-lease IssuesSubleasing and Assignment

Subtenant’s Guide to a Great Deal

Looking for a great deal on office space?  A sublease may be the answer.  Subleases are often attractive to businesses as they offer a low cost, flexible, turnkey solution.  Start-up companies and established companies can find subleases to be a great opportunity.  They are, however, not without challenges and risks.  In this post, I discuss the advantages and disadvantages of subleasing and how businesses can navigate the sublease process to get a great office space that will help propel their business. Continue reading

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