Commercial real estate landlords and tenants are attempting to navigate unchartered waters in the wake of the COVID-19 economic shutdown. With restaurants shuttered and work-from-home orders in place for non-essential employees, there is more unknown than known in understanding how and when the economy will open up again.
So, where does this leave the thousands of tenants with long-term lease agreements whose office spaces sit empty? What are landlords doing to help with rent relief? We talked to commercial real estate expert Craig Petersen, VP at Kidder Mathews in San Jose, California, to get an insider's perspective on the current commercial real estate climate. Petersen has extensive expertise working with corporate clients with strategic real estate planning, site assessment, acquisition and disposition, with companies ranging from first round start-ups to Fortune 500 corporations. As a tenant rep for clients mainly in the tech industry, Petersen has experienced many highs and lows based on the shifing economy.
Cash Conservation Mode
“What I’m dealing with now is tenants trying to figure out how they can conserve cash,” Petersen said. “Especially startups that have a burn rate and they want to keep the burn rate low. The common opinion across the industry is VCs are not going to be doling out money when things are so uncertain. It’s going to be harder to raise money and harder to get better valuations. Employers are looking for ways to bring down expenses and the quickest ways to do that are to cut staff, reduce pay, or reduce your office space."
Rent Relief for Tenants
Reducing office space is not an immediate solution for many companies at the mercy of landlords and long-term lease agreements. And while landlords have the option to offer rent relief, they aren't required to. "There is no standard and it’s make it up as you go. Every landlord is doing something different," Petersen said. "Some landlords are giving relief to tenants that will be able to come back to business. It’s easier than finding new tenants or having the property sit empty for months and months." Landlords don't always have the option to offer reduced rent because they have to pay their own lenders. Petersen is seeing some landlords offering one month rent relief, in return for extension to the lease. It might sound nice on the surface, but that offer won't pay off if you want more flexibility moving forward and companies might be better off paying rent today.
Reduction in Office Space
As companies prepare to return to work and bring employees back into the office, there are mounting concerns around safety, hygiene, and security as well as how to best utilize an existing office space or find a new one. Employers will increasingly prioritize social distancing in the workplace, which translates to fewer desks and more space (and walls) between workstations. "Floor plans will be more spread out," Petersen said. "Shoulder-to-shoulder work benches will be put on hold. I could see a return to private offices eventually, but that’s an expensive buildout."
In startups, where the office culture is relaxed and collaborative, closed off spaces will be less than ideal. "You want people to be in a space where they can communicate and exchange ideas," Petersen said. "Everyone in a private office doesn’t bring that together."
Lease Negotiations and Downsizing
The standards for lease terms and negotiations could shift as well. Some companies will see a decline in the market as an opportunity to secure a long-term deal for cheaper, and others will need to downsize because of layoffs or an increase in remote working employees. According to Petersen, we haven't seen the low point for rents yet. "Probably in 6 months we will hit the low point for rents. At that point you’ll want a long-term lease because you’ll get way better rent. My guess is we will have some downward pressure. There are a lot of subleases coming on the market, and that’s an indication of lower rents because they can do a lower term."
Petersen predicts the market will see a lot of downsizing as tenants have less need for larger office spaces and companies go out of business. "There are some select companies that are doing okay, but I think almost everyone is hurt by this."
The reality is that construction will eventually pick back up, but there could be a slowdown in new buildouts. In 2008, many construction projects were halted halfway because of the economic downturn, and once the economy began to pick back up, securing second half loans weren't so easy. "If lenders have trouble then we might see challenges with getting construction loans. New stuff will probably get put on hold, and construction will be hurt by this."
As companies begin the slow climb out of shutdown and quarantine, it will be important for stakeholders to adopt processes and technologies that protect and equip the most valuable asset: the people.