Faced with a situation where many corporate tenants may be looking at switching to at least partial remote working model, office landlords are getting ready to offer more flexible workspaces and lease terms.
Flexible remote working arrangements could modestly accelerate companies’ adoption of short-term leases, likely serving as a headwind for office demand in the short term, according to a MetLife Investment Management report on office demand. (In the long term, MetLife Investment Management expects limited impact on office demand, forecasting that while many firms will try permanent work-from-home arrangements, a substantial number of those arrangements will not work out).
Prior to the pandemic, the market was saturated with independent flexible space providers, who signed long-term leases with office landlords and then sublet that space on a short-term basis to end users, creating “a potential long-term liability, short-term cashflow mismatch,” according to Will Pattison, head of real estate research at MetLife Investment Management.
“We believe flexible space as a service is here to stay, but the typical lease structure needs to change,” Pattison says. “We believe landlords and flexible space providers should generally be signing operating agreements, similar to how hotel brands sign operating agreements with hotel real estate investors.”
Traditional office lease terms normally range between five and 10 years. Pattison expects traditional tenant renewals in 2020 to generally target one- to two-year terms as tenants figure out what their longer-term space needs will be. Some tenants may downsize, while others may opt to add private offices and lease more space in order to accommodate social distancing guidelines.
“Despite the immediate challenges that we are all familiar with presented by the COVID crisis, the third-party [office space] provider will still be a viable business going forward,” says Al Pontius, senior vice president and national director for office and industrial assets with brokerage firm Marcus & Millichap. “But there will absolutely be landlords, probably more of the larger landlords, that within their portfolios, they allocate a percentage of their space to offering more flexible terms and even a co-working environment.”
This trend was already underway before the pandemic, with traditional office landlords, including Tishman-Speyer and WashREIT, launching their own co-working brands in their buildings to compete with the likes of WeWork.
One of the primary issues with the short-term leases is the less certain property income, according to Pattison. But in the current environment, office landlords may have to work with the demands of the market.
“It’s tough. It’s not amazing for landlords. There’s a reason why landlords like long-term leases,” says Jonathan Wasserstrum, CEO of SquareFoot, an office space rental agency. Having long-term leases makes it much easier to secure mortgage financing.
But, he adds, “The thing people are starting to recognize at the end of the day is landlords are in a service type business where they have clients. Once somebody starts offering something to the market, assuming it’s something that people want, in this case shorter term deals, then you have to figure out how to offer that to your clients.”