Lego announced in January it was moving its headquarters from Connecticut to Boston. Last year, Meta closed one of its New York offices, and Twitter reportedly stopped paying rent on one of its buildings in San Francisco.
These companies are among a growing number of firms rethinking their real estate holdings. About 87% of corporate real estate leaders say optimizing their company’s property portfolio is their top priority, even more than return-to-office plans, according to a survey by commercial real estate firm CBRE.
“Real estate is really an enabler of business strategy,” says Georgia Collins, executive managing director at CBRE. “So the first decision always has to be, ‘What is the business need?’”
For most firms, that need is clear: cost reduction amid economic uncertainty.
CBRE estimates that fixed logistics costs, which include real estate, account for between 3% and 6% of a company’s logistics costs. But reducing commercial real estate expenses is more complex than other items on the balance sheet. Leases are long and legally binding, and the declining value of office space has created a buyer’s market, making profitable sales of large office spaces unlikely.
A commercial tenant can’t stop paying rent on a lease any more than a person in a residential building can. The problem is that the long-term nature of office leases means companies have limited flexibility in shedding a cost they’re forced to carry on their balance sheets for years. The New York City Department of Small Businesses estimates the average length of a commercial lease in New York City—the country’s largest commercial real estate market—is 10 years.
Therein lies the bind: Commercial leases are difficult to break because they’re long, and companies are desperate to break them precisely because, as long-term liabilities, they’re prime candidates for cost restructuring.
“When the economy becomes clouded, smart CFOs look at their cost of capital and sources of liquidity,” says Chris Niehaus, U.S. head of BentallGreenOak, a commercial real estate investment firm. “Real estate is a good [source] to create liquidity to run your business because it’s not generally a core part of your business.” That’s especially true as companies increasingly embrace remote work.
The best solution, according to Niehaus, is for companies to find a subletter for part of their office space. Though he acknowledges that a prospective subtenant would likely negotiate a price per square foot lower than the original rent, given the current buyer’s market, subletting at least alleviates the financial burden.
Columbia professor of real estate finance Stijn Van Nieuwerburgh says there is currently a tertiary and quaternary market for commercial subleases. “There are subleases of subleases of subleases,” he says. “It’s like a hot potato that has been passed from company to company.”
The situation is even more rigid for companies that own their office buildings because commercial mortgages are refinanced at the end of the original loan period, not during. The standard length of a commercial mortgage is 10 years, says Van Nieuwerburgh, meaning only loans issued in 2013 are available for refinancing this year. Companies eligible for mortgage refinancing this year will face higher interest rates and added scrutiny from banks that view empty offices as riskier investments than in the past, he adds. Some companies might even walk away from their office buildings entirely if the decline in property value exceeds their initial mortgage down payment.
“At that point, they just throw in the towel,” Van Nieuwerburgh says. “They give the keys of the office to the bank and tell the bank, ‘Good luck.’”
Niehaus likens the piecemeal fashion of potential foreclosures to “a slow-motion train wreck,” in which the market for office space eventually bottoms out.
It’s increasingly common for companies that are able to evade their leases or sell their properties to move into new offices, according to industry experts. But they typically transition to smaller offices in nicer, highly amenitized buildings that include state-of-the-art kitchens, employee lounges, laundry, and childcare services. For executives who still value the in-person experience, “the thinking is, ‘We really need to incentivize our employees to come into the office, and we’re going to do that by offering them nicer office space,’” says Van Nieuwerburgh.
That’s not the case for many companies. Firms that either can’t afford to move or simply don’t want to are still stuck with an expensive line item and underutilized asset. “A-plus spaces are actually doing quite well,” Van Nieuwerburgh says. “But that’s the top of the market, and that leaves a lot of the market doing very, very poorly.”
Diane Hoskins, co-CEO of architecture firm Gensler, says companies that decide to move to a new location for financial reasons should focus on effective change management to assist employees in the transition. “That means talking to people and bringing them into the process,” she says.
And even if the move to a swankier but smaller office ultimately has negligible cost savings, it still appears to shareholders like a more efficient use of company resources. Collins says this is because real estate is a “visible cost.” An empty office looks and feels more wasteful than, for example, losses due to shrinkage along the supply chain.
“C-suite-level folks walking into offices are concerned about an asset they have that is underutilized,” Collins says. “It’s one thing that is prompting a lot of these conversations right now.”
With office spaces shrinking, CBRE advises clients to use new metrics to measure their office utilization rates. The previous standard metric was rentable square feet (RSF) per person, which based the required size of an office on the total number of people working there and assumes everyone will always be in the office simultaneously. Now the go-to metric is square feet per seat, which better accounts for the world of remote and hybrid work. Using square feet per seat, companies can better assess whether a smaller office actually fulfills the same needs as a bigger one. “We can also expand it to say, ‘How good is the experience per square foot?’” says Collins.
Still, she’s hesitant to issue a blanket statement about a desirable square-foot-per-seat rate because it’s too dependent on a company’s industry, size, and performance. Nonetheless, the new metrics offer a way to evaluate the effectiveness and use rate of an office’s real estate costs. Hoskins, echoing a similar sentiment, tells her clients to “lean into the math.”
While unused office space exerts financial pressure on companies looking to minimize their expenditures, the current market distress makes it an appetizing investment for those with solid balance sheets and plans to expand, Niehaus says. Those companies might consider the current cut-rate prices as the perfect time to acquire office space before prices eventually increase. “If you’ve got a good business model, and you know you’re going to use that real estate long-term, and you can buy it at a 25% discount, it’s a really smart corporate finance move,” Niehaus says.
Not all commercial real estate assets hold the same weight, though. “Warehouses are the darling of commercial real estate,” Niehaus says. Demand for them remains strong after the pandemic accelerated the e-commerce boom, which depends on sprawling fulfillment centers to store and ship products to consumers’ homes.
Even though other, less showy real estate classes remain strong investments for companies, Niehaus has no illusions about the difficulties facing offices: “The bull’s-eye target is on the office sector.”
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