Employees for businesses of all sizes are coming back to the office as leaders emphasize the value of being together for information sharing, cohesive culture, mentorship and training. But the office space that they’ll return to is changing.
As many office-based businesses see the return of employees, businesses are reimagining how they handle their real estate. Occupiers are pursuing a “flight to quality,” looking to give their talent better space as a reason to return and address new work dynamics. Newer buildouts, modern finishes, upgraded furniture and amenities are expectations in improved, sometimes smaller, spaces.
Landlords are recognizing the flight to quality, responding by improving their buildouts to attract top-caliber tenants. Having that space built out shortens tenant decision time and increases the likelihood of attracting great tenants.
“The flight to quality goes two ways: it helps employers get their employees back to the office with a more attractive work environment while also reducing the leased footprint,” says Nathan Kelly, President and Managing Director of Cushman & Wakefield | CRESCO Real Estate. “And landlords that embrace the flight to quality with greater amenities in a ready-to-go, built-out space are pulling in high-quality tenants.”
Smart Business spoke with Kelly about recent trends in commercial office real estate and how both landlords and tenants can capitalize on them.
How are tenants and landlords reacting to these changes?
Landlords continue to feel the downward pressure on rents from the post-COVID high vacancy rates, especially downtown. But while they might, in the short-term, need to bring the rent down a little to entice tenants, the smaller, better designed footprints could potentially increase the number of tenants and increase revenues for the overall space.
From the tenant perspective, the flight to quality is generating value through modern spaces in a smaller footprint than would have been desirable a couple of years ago. These are more functional spaces that are creating a stronger draw for employees to come back to the office, without spending more on real estate.
Additionally, there are sublease spaces available in this market. But finding one that meets a prospective tenant’s needs is less likely than many could have anticipated. That’s either because it’s not built out appropriately, or the terms were better for the outgoing tenant than they are for the incoming tenant. Finding a perfect match in the sublease space requires more research and nuance — they’re out there, but they’re hidden.
How are these trends affecting lease terms?
Vacancy is a landlord’s most frustrating expense. So, landlords prefer longer lease terms and high-credit tenants. Oftentimes, longer terms can also benefit the tenant, incentivizing a landlord to invest and create better spaces to capture their return on investment.
During COVID, many tenants addressed existing leases in one of two ways: short-term lease because of uncertainty, or a ‘blend and extend,’ which is to renew early and extend for a longer-than-normal period. For landlords facing the same uncertainty, that strategy assuaged some of the fear in exchange for a lower rent number. Fast forward to today, many of those short-term leases are coming due. That’s creating an opportunity for well-positioned landlords as a glut of tenants face a real estate decision. The time for value-seeking tenants to strike is between now and the next three quarters, given that rents will trend upwards as more inventory is taken off the block in this flight-to-quality conversion.
What advice would you offer investment buyers?
Buyers should keep their head on a swivel because there are going to be buildings that are not able to meet the expectations of the flight-to-quality trend, either because the landlord is over leveraged, or they got caught flat-footed. There will be landlords that find that their building got empty fast, and their revenues are down. Well-capitalized buyers could, in this environment, find tremendous value in the office market. ●
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