Lease Renewals Trigger Office Changes

Lease renewals in the office sector are often used by companies to realign their office space requirements, but the “blend and extend” model that often meant renting more …

Lease renewals in the office sector are often used by companies to realign their office space requirements, but the “blend and extend” model that often meant renting more space has shifted as businesses attempt to make their workplaces more efficient. Industry experts are calling the new model “rightsizing” rather than downsizing as many office renters adjust to accommodate a more mobile workforce. Studies show that fewer people are coming to work in favor of telecommuting or flex time and businesses have found cost savings by renegotiating during lease renewal time to account for the need for less space. For more on this continue reading the following article from National Real Estate Investor.

Gone are the days when a lease renewal was a simple matter of agreeing on a new rental rate and signing on the dotted line. These days, renewals are triggering an opportunity for tenants to revamp space to fit their changing needs.

The “blend and extend” lease renewals that were all the rage a few years ago are being replaced by companies that are “rightsizing” space. Blend and extend renewals were viewed as an ideal way to handle the uncertainty in the economy and capitalize on lower market rents. Now that the economy is improving, companies have a clearer view of the future and they want their real estate decisions to better reflect their corporate strategies.

Renewals have unleashed a wave of consolidations among corporate tenants. Large companies in particular are downsizing as a means to cut costs and adapt space to fit new workplace dynamics. “Most people don’t go into an office and sit at a desk from 8 to 5, five days a week,” says Ned Tarbox, a vice president, corporate solutions at Jones Lang LaSalle in Minneapolis. “Corporate real estate leaders are starting to recognize that and align their properties towards those new work styles.”

Tarbox recently worked on a deal in downtown San Francisco where the client was underutilizing its 130,000-sq.-ft. space and shifting to a more mobile workplace model. Although the number of workers did not change, many workers were not commuting into the office five days a week. In fact, many weren’t coming even three days a week. By using the existing space more efficiently and creating shared workstations, the company reduced its footprint by almost 70 percent, notes Tarbox.

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As leases expire, companies are analyzing their current space needs, recruiting strategies, workplace trends, and how the  company’s overall image is tied to that office space. “Given those kind of considerations, I don’t believe it is downsizing as much as it is a rightsizing effort to best meet changing real estate needs,” says Jordan M. Weidner, a vice president and principal with Cassidy Turley in Cincinnati.

In part, companies are accommodating the generational shift with more Millennials (whose ranks were born in the 1980s or later) now working side-by-side with Gen Xers (those born in the ’60s and ’70s) and baby boomers. Millennials tend to prefer more collaboration and shared space. And workers across the board are increasingly mobile. “The theme we are seeing is that companies are really struggling with renew in place versus going to a new site to implement these workplace strategies,” says Bob Chodos, a principal with Colliers International in Chicago.

In some cases, it is easier to relocate to a site that has the space configuration, technology infrastructure and amenities already in place rather than gutting an existing space and giving it a complete makeover. Chodos says about half the firms he works with decide to relocate rather than renew. 

Tenants hold bargaining power

Part of what’s enabling this trend is that tenants remain in the driver’s seat in lease negotiations. After remaining flat at 17.0 percent in the prior quarter, national office vacancies declined by 10 basis points to 16.9 percent at the end of the third quarter, according to Reis. In most markets across the country, there is still an ample supply of space available and very little new construction occurring. Landlords know that in order to keep a tenant they have to provide the same types of incentives as they provide to new tenants. “So, landlords are still being very aggressive on free rent structure and improvement allowances,” says Weidner.

The desire to revamp existing space means a bigger demand for tenant improvement (TI) dollars. Oftentimes, tenants that opt to renew are pushing for more TI dollars and greater flexibility. “If firms are renewing for any period of time, they most likely are not keeping things the way they were. They are reinventing the way they work, and I think that is a general trend that will continue,” says Weidner. In exchange for the bigger TI packages, tenants are committing to longer term leases. For example, the typical 3- to 5-year lease terms are being replaced by 5- to 7-year deals.

Historically, landlords have not wanted to offer the same amount of TI dollars for renewals as opposed to new lease deals. However, existing landlords are being forced to be more generous due to the competition that exists to woo those tenants. In Chicago, for example, some large tenants have been able to get $60 per sq. ft. to $80 per sq. ft. in TI allowances, six to 12 months of gross free rent and rental reductions to take base rents in line with market rents, notes Chodos.

The economics of a deal are always the top priority. But, given the changes occurring in the workplace and cautious mentality that remains among many companies, tenants are seeking greater flexibility in terms on lease renewals. That lease flexibility comes in the form of termination rights, contraction rights, expansion rights, first rights of refusal for rights to expand. “Lease flexibility, next to lease economics, is the most important driver that tenants look for in the market,” says Chodos. “It also is the number one thing that landlords hate to give you.”

This article was republished with permission from National Real Estate Investor.


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