The Next Shoe to Drop: The Death of Normal Business Hours

A lot has been written over the past two months about the new work from home paradigm. The realization that much of the work we do can be done from anywhere has major ramifications for both office space demand and corporate culture.  This may only be the tip of the iceberg, however. Now that we have acknowledged that work can be done from anywhere, the next logical leap will be the recognition that work can also be done at any time.  The terms “normal business hours” or “five-day work week” will become anachronisms.

In the days before electricity, the workday was primarily driven by daylight hours.  As soon as natural light faded in the evening hours, we lost the ability to be productive. Thanks to Thomas Edison, in the late 19th century, artificial light enabled employers to extend the workday and, in certain cases, this led to the exploitation of workers.  In the United States, the 9 to 5 workday and the five-day work week (or what we now accept as “normal business hours”) was a concession gained by the unions fighting against sweatshops in the late 1920s.  While the 40-hour work week has certainly expanded for many professions over the years and many people work 60 hours or more per week and more than five days, if you take public transportation or commute during “rush hour”, it’s clear that a large portion of the work population still functions materially within the 8 a.m. to 6 p.m., Monday through Friday work paradigm.  That is going to change.

If employers are now accepting that you don’t need to be in the office to get your work done, why should they care what days or time of day the work is performed?  Certainly, if a job requires interfacing with clients or colleagues or supporting certain constituents, the individual will need to conform his or her schedule accordingly. The same will apply to individuals whose job is tied to a particular service that has set operating hours such as stock traders on a public exchange or people in the hospitality or entertainment industries.  However, many jobs and tasks can be performed independent of other people or services.  For them, why do they need to be in the office at 9 a.m. and gone by 6 p.m. when the building’s HVAC system shuts off?  If they can complete their assigned work in three days by putting in 13 hours per day, why insist that they work more, shorter days?

For years, companies have operated their factories and call centers with multiple shifts to get more than eight or 10 hours of production from their real estate.  Office space will soon follow suit.  This transition may be imposed on many workers in the coming months as we start to gradually re-enter the workplace prior to a vaccine or treatment for COVID-19.  One way to de-densify the workplace will be to extend the workday into multiple shifts separated by vigorous cleaning in between.  It’s not a reach to see businesses breaking the day up into a 7 a.m. to 1 p.m. shift and then a 3 p.m. to 9 p.m. shift.  This arrangement would have the added benefit of enabling two income families to share childcare duties during the day so each spouse could get some meaningful time in the office. 

As we start to contemplate a more flexible work schedule, the concept of a normal work week will change.  It won’t matter where you work, what days you work or what hours you work.  From an employer’s perspective, the ultimate questions will be “Were you productive and did we get our money’s worth?”  If the answers are “yes”, employees will be given more freedom to set their own schedules.

What does this mean for the future of commercial real estate? 

  1. Companies may need less space if multiple people are using the same desk or work area.  It’s really an extrapolation of hoteling.  With hoteling, a company provides fewer seats in the office than they have employees with the understanding that, on any given day, not everyone will be in the office.  With the expanded workday and multiple work shifts, however, it’s possible that multiple people will be using the same seat on any given day.
  2. Office buildings will need to expand their basic services.  Most office buildings agree to provide basic services including HVAC during “normal business hours”.  Normal business hours are typically defined as 8 a.m. to 6 p.m., Monday through Friday, and 9 a.m. to 1 p.m. on Saturdays (or something similar).  If you want “after hours” HVAC, it costs more. The same applies for cleaning and other services.  That has proved to be sufficient for most businesses until now.  That is going to change as 9 p.m. will become the new 5 p.m. for some workers and the presumption that people don’t work on weekends may change.
  3. Under-parked suburban office buildings will get relief and so will commuters. Many office parks developed prior to 2000 were planned for parking ratios of 3 or 4 spots per 1,000sf of office space.  While this made sense based on the generous workplace densities of that time, today, densities are much greater and, as a result, many suburban office parks can’t compete for tenants.  If we spread out the workday and reduce the number of days that everyone is coming into the office (plus take account of telecommuting), we will lesson the demand on parking throughout the day thereby enabling older parks to compete for tenants.  In addition, the driving commute should ease as the traditional “rush hour” will be spread more widely throughout the day. This may help office parks in secondary and tertiary markets as the commute times will decrease.
  4. Companies will need to work harder to create and maintain their corporate culture.  Just as remote working will make it harder to establish a cohesive work environment and corporate culture, if the workday is expanded so employees are not overlapping in the office as much, it will put added pressure on companies to find ways to bind everyone together. The construct of a 9 a.m. to 5 p.m. workday in the office created shared routines and rhythms that defined what it meant to be an employee of Company X.  As we start to untether ourselves from the office and move away from standardized work hours, we will lose a lot of the commonality that bound us together as coworkers and defined our corporate culture.       

Conclusion

The way we define the work experience is changing at lightning speed.  Over the past few months, we have expanded the definition of the acceptable workplace.  We are no longer constrained by physical walls or buildings as we recognize that work can be done from anywhere.  The next logical phase in this evolution is casting aside the arcane construct of normal business hours or workweeks.  If we can work from anywhere, we can certainly work at any time.

This article was published in the Philadelphia Business Journal on June 17, 2020.

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When Office Demand Becomes Elastic

Historically, demand for office space has been relatively inelastic because businesses viewed it as a necessity. If a company needed 20,000sf to run its business, it generally leased that space whether the rent was $30/sf or $35/sf. That philosophy may be changing because, with the acceptance of remote working, companies will have more flexibility in determining the amount of space they truly need. While demand for essential space will remain relatively inelastic, a growing portion of every company’s space requirement will become more discretionary and, therefore, dependent on the rent.

Inelasticity and Elasticity of Demand. Demand for a good or service is said to be “elastic” if a change in price causes people to demand disproportionately more or less of that item. Demand for a good or service is said to be “inelastic” if a change in price causes people to make relatively no change in how much they demand of that good or service. Demand elasticity or inelasticity is measured on a relative scale as demand for different goods and services react differently to different movements in price. The more essential a good or service is, the more inelastic demand will be because people have no choice but to consume that item. Thus, items like gasoline, utilities and food staples have relatively inelastic demand. Elastic goods and services, on the other hand, are much more common and tend to be more discretionary like luxury items. Every manufacturer and service provider must have a keen understanding of the elasticity or inelasticity of demand for their product or service so that, when they increase or decrease prices, the result will not negatively impact overall revenues (by disproportionately reducing demand or failing to increase demand, as the case may be).

Office Space Demand. While it is true that businesses may consume less office space in very high rental markets like New York City, Tokyo or London than they might in relatively cheap rental markets like Indianapolis, Philadelphia or Miami, within a given market, companies tend to lease what their space programming dictates. Office space has been a necessary cost of doing business. Going forward, however, the definition of what is truly “necessary” will change.

Assume that XYZ Company was paying $800,000/yr. in rent for 20,000sf of office space (i.e., $40/sf in gross rent) and that every employee had a dedicated seat. If rents go up to $50/sf for this space, the company would be faced with a potential 20% increase in total occupancy costs if it continues with the same space program (i.e., $50/sf X 20,000sf = $1MM). However, with the broader acceptance of remote working resulting from the pandemic, companies will now have more discretion in how much space they need. If the CEO of XYZ Company mandated that there be no increase in real estate spending going forward, the company could offset the rent increase by adopting a hoteling model (i.e., plan for fewer seats than the actual number of employees) and thereby reduce its demand by 20%  (16,000sf X $50/sf= $800,000). While XYZ Company may have a relatively inelastic demand for the “essential” 16,000sf of space, the remaining 4,000sf of space is more of a luxury and, therefore, whether it ultimately elects to lease this space will be dependent on the actual rent.

Many people are predicting that businesses will stop leasing space or at least take less space because of remote working. However, in most cases, it’s really going to be matter of price. If landlords want to hold out for higher rents, tenants will decide to forego some of the discretionary space that they would otherwise have elected to carry. If, however, rents come down sufficiently, tenants may decide the value justifies the additional consumption. Again, going forward, for every business, space will be broken down into essential, “inelastic” space and nonessential, “elastic” space.  The “elastic” space will change the office market.

How This Will Affect Lease Negotiations. What will all of this mean for lease negotiations? In the past, the lease negotiation was primarily about rent and tenant concessions. Going forward, however, negotiations may add the new element of square footage as tenants will be able to more easily manipulate their program to accommodate their budgets. Companies will instruct their design professionals to create different test fit plans: one with the ideal space configuration assuming rent is not an object, and a second plan that assumes they can lease only the amount of space that accommodates their real estate budget. Tenants will then need to weigh the relative pros and cons of the ideal space plan with higher costs against the workable space plan and lower costs. Landlords (and their lenders) may also have to make a choice: do they want the deal that affords them a higher rent but with more vacancy or do they want the lower rent and less vacancy?

The flexibility to manipulate its square footage will increase a tenant’s bargaining leverage at the negotiating table because it will enable it to fit its requirement into more buildings in the market and to create multiple options for each building. More buildings and options in play means more landlord competition and that always works in the tenant’s favor.

Conclusion. The acceptance of remote working will provide businesses with more flexibility regarding the amount of space they lease. Going forward, many businesses will bifurcate their space requirement into essential or “inelastic space” and discretionary or “elastic” space. The acknowledgement of the elastic component of their demand will add a new dynamic to space planning and lease negotiations, and ultimately create downward pressure on rents.

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Reports of the Death of the Office Are Greatly Exaggerated

The relative success with which many companies have transitioned into virtual workplaces during this pandemic has many predicting the death of office space. This couldn’t be further from the truth.  In fact, without the critical time spent together in the office developing important personal relationships and unifying corporate cultures, many companies would not be able to survive this new, remote experiment.

There is no doubt that remote working is here to stay and will be a much larger part of our working habits going forward.  There is also no doubt that companies will be consuming less office space than they did before and that rents will gradually start to come down as a result.  However, if the last three months have taught us anything, it is how important a strong foundation is to surviving hardships.

Let’s say a couple is together for 10 years and then, because of work, one partner is forced to move away for six months.  If they make it through this physical separation, does that mean that they don’t really need to be together in the same location anymore and that a remote relationship is just as fulfilling?  No.  The fact that they even survived the six-month separation is probably due to the strong foundation they built by living together for the 10 years prior and the expectation that they will eventually be together again. The same will hold true for companies.  To look only at how well companies are doing with remote working over the past three months independent of the foundations built in the years prior would be foolish.

While many companies are surviving during COVID-19, how many outside of essential, life sustaining businesses like supermarkets, personal protective equipment companies and liquor stores are thriving?  It’s one thing for an established company to maintain the status quo or even hold it together during this pandemic, it’s another thing to build a company from scratch or aggressively grow a company in a totally remote work environment.  Ask the founder of any successful company whether they would have been able to survive nonetheless achieve their ultimate success without the daily interactions, collaboration and team spirit that was first cultivated in their garage or offices and most will tell you “no way.”  Even if it were possible, would the experience of building a company have been the same if the people weren’t in the same place high fiving each other with each new account or product launch?

Only after a company has built a strong foundation and their employees have established important relationships with their co-workers, can it afford the luxury of remote work arrangements.  Jack Dorsey, the CEO of Twitter, recently announced that they will allow all their employees to work remotely for the indefinite future.  Twitter now has close to 5,000 employees and does almost $3.5Billion in annual revenues.  Would they have ever gotten to these numbers as a completely virtual company from day one?  Probably not.  The same goes for Microsoft, Google, Apple and almost every other company. In each case, their office culture was essential to their financial success and defining who they are as a company.

There is a lot to like about working from home and the flexibility it provides us. However, before we become too enamored with this experience, which is shiny and new to many of us, we should remember that, not too long ago, work from homers lead a work revolution.  Immediately prior to the pandemic, over 3 million people worked from over 19,000 coworking locations worldwide. The coworking industry sprung up in 2005 because thousands of people became tired of working in isolation from their homes. They were attracted to the community and ecosystems that coworking offered and was lacking at home.  The recent financial hardships of WeWork well documented in the news and the struggles of most co-working companies resulting from the Coronavirus do not detract from the important need this industry filled. Remote working has a place in our work future and is a nice supplement to other working arrangements. But as an exclusive, long-term condition, it is probably not the panacea many of us currently believe it to be.  Been there, done that.

Conclusion

COVID-19 has forced most of us to leave the office and work from home.  Despite children in the background and a lack of preparation, this arrangement seems to be working.  However, before we become too enamored of this new work paradigm, we should appreciate that its relative success is due only to the strong foundations that were built in the office prior to the pandemic.  The relationships between a company and its employees or among coworkers are no different than the personal relationships we cherish in our lives.  While they may survive periods of separation, they only thrive if there are meaningful periods of time spent together.  Yes, the way we work has probably changed forever. However, we will still need office space to be successful and fulfilled. See you at the water cooler.

This article was published in the Philadelphia Business Journal on June 2, 2020

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Four Reasons Philly Should Thrive After COVID-19 (at New York’s Expense)

The COVID-19 pandemic has brought the Delaware Valley’s economy to a screeching halt. However, there is reason for optimism in our region once we emerge from this crisis.

As a general matter, the United States has thrived right after major disruptions to our economy. Following World War I and the Spanish Flu pandemic, we entered the Roaring Twenties. Following World War II, we entered the Baby Boom and the largest economic expansion in our history up to that time. More recently, we just ended one of the longest economic expansions in United States history following the Great Recession of 2008.

Beyond these general types of rebounds, however, there are four reasons why our region may uniquely thrive once this pandemic ends.

  1. Geography will finally work to our advantage. For years, Philadelphia has tried to sell itself to businesses based on its proximity to New York and Washington, D.C. Unfortunately, it’s exactly that proximity that has hampered our growth. Why move your business to a city that is close to where you really want to be when that ideal place is only two hours away? Just look at Amazon. They split their highly coveted headquarters between these two markets two hours to our north and south and bypassed us completely. Things going forward may be different. Emerging from this COVID-19 crisis, companies will embrace remote working to a much larger degree and, as a result, won’t expect everyone to be in the office every day. That’s a game changer as it will allow companies to draw talent from a much broader geographic area thereby enabling them to locate their offices in cheaper cities like Philadelphia. One- or two-hour commutes won’t prevent people from taking a good job if it’s not an everyday thing. Remote working may also result in a lot of New Yorkers relocating to Philadelphia even if their job is in Manhattan. Whereas someone may have thought long and hard about living in Philadelphia and commuting to New York City five days a week, they might feel very differently if they only need to travel there five or 10 times a month, especially if they can buy a house or condo here for a third or half the price. 
  2. Our “Eds” will lead the wave of the future. For years we have been touting our “Eds and Meds” economy. Well, the education part may take front and center stage post COVID-19. By necessity, schools around the country have been forced to adapt to a virtual classroom. This transformation happened overnight and without any preparation. As a result, it’s been a bumpy transition. However, we are going to perfect virtual learning in the coming months and it will become an integral part of our national education system in the future. Given that we have more colleges and universities than virtually any other city in the country and are blessed with visionary leaders like Amy Gutmann and John Fry, would you bet against us as the place that figures out how to provide affordable (and maybe virtual) college education for everyone?
  3. Our “Meds” will be more important than ever. Over the past several months, each of us has come to appreciate how important it is to have access to the highest quality medical care. Which city would you want to be living in right now if you needed hospitalization, New York or Philadelphia? We are home to some of the best hospitals and healthcare systems in the world and are at the vanguard of new gene therapy and immunotherapy. Going forward, quality of healthcare and ability to access it will be much more important to people and companies when deciding where to locate. We should be towards the top of everyone’s lists.
  4. Our parks and walkability will make us the city of the future. You don’t appreciate the abundance of grass in Philadelphia until you move here from the suburbs with a dog who won’t poop on concrete. Trust me. I know from experience. When visiting my children in New York City, I walked for 40 minutes until my poor dog could relieve herself. In Philly she’s always five minutes away from a “bathroom.” 

William Penn was prescient when he incorporated five city squares into his plan for Philadelphia including what are now known as Rittenhouse, Logan, Franklin, City Hall, and Washington Squares. About 150 years later, Philadelphia created Fairmount Park and, thereafter, Penn’s Landing and the Schuylkill River Trail. You don’t get proximity to large, green spaces in New York City unless you’re rich enough to live by Central Park.

The beauty of Philadelphia is that it was planned before we had cars. That means you can walk almost anywhere including to your office. Given your choice between commuting via crowded public transportation in New York City or walking in Philadelphia, which will most city dwellers prefer in the future?

Conclusion

These are extremely hard times for all of us as we struggle to come to terms with in-home quarantines and the looming recession. However, this is not the first catastrophe we have faced, and history tells us that, as a country, we can expect prosperity when this is over. However, for Philadelphia, the future may be particularly bright as people start to focus on what is really important in life and the simple pleasures. Let’s get through this crisis and then seize the day.

This article was published in the Philadelphia Business Journal on May 8, 2020.

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Don’t Overreact to COVID-19 When Your Employees Return to Work

Over the coming weeks, executives are going to be inundated with articles and white papers telling them that, to survive in the post COVID-19 business world, they are going to need to completely change their space, their furniture and their employee densities. Already we are being told by furniture vendors, designers and brokerage firms that no one is going to want to sit next to each other anymore and to do so will be a safety hazard. Not so fast.

Immediately after 9/11, the consensus was that no one was ever going to ride in an airplane, live or work in a major city or develop, lease, finance or ensure a trophy office building again. We had just been hit with the worst foreign attack on our continent in over 200 years and people were rightfully very scared. While some companies decided to relocate to less high-profile office buildings as a result of these terrorist attacks, over time, there was a flight back to quality and the nicest, tallest buildings filled up. For most of us, our worst fears about the future when we awoke to a new day on September 12, 2001 dissipated relatively quickly. While we changed our building and life safety codes to address new risks, ultimately, businesses really didn’t change much about how or where they consume office space. 

Distinguish between temporary and permanent changes in behavior

Now we are faced with a new life shattering event, COVID-19. Will companies reflexively change the way they build out their office space based on this once every 100 years occurrence or will they stop, take a breath and rationally determine which changes in behavior will be permanent, and which are only a temporary response to an acute problem? For example, our recent experience with remote working has proven that many jobs can be performed outside of the office and, as a result, these types of arrangements will be factored into future space planning programs. This and other fundamental changes in staffing such as outsourcing will no doubt reduce the amount of space businesses consume. On the other hand, changes to protocols or behaviors based on the fear of spreading and catching a deadly virus (i.e., distancing) are probably only temporary.

We are already seeing recommendations for changing panels on workstations from fabric to laminates, creating more individual offices, converting benched seating into workstations and building double wide corridors so that people don’t need to be too close to each other. These are expensive and long-lasting changes that are obviously a reaction to the heat of the moment. Most offices are currently laid out the way they are because the company’s management, in conjunction with their designers, decided this was the optimal layout for the employees given the company’s business and culture. While completely changing furniture systems and layouts will make a lot of furniture vendors, designers, landlords and brokers happy (if companies take more space), tenants may soon regret such reflexive changes if they detract from their business and impose significant, unnecessary costs.

Everyone wants to do what is best for their employees, and now, more than ever, their employees’ health, safety and wellness are front and center for every CEO. However, it’s important to remember that, even if everyone sat six feet apart today, most employees still wouldn’t be allowed in the office today. We’re in a pandemic and extraordinary precautions have been put in place to protect our health.  This crisis, however, will hopefully recede into the past in the next 12-18 months. Americans have proven that they have short memories when it comes to catastrophes and they are likely to revert to old behaviors that are comfortable and convenient. 

Rushing to make expensive and permanent changes to accommodate social distancing (as opposed to fundamental changes in remote working or outsourcing) may not only turn out to be bad long-term investments, but they may also have the unintentional effect of pushing people to work from home. Once the government-imposed quarantine is lifted, the main reason people will go into the office will be to interact with their co-workers and be near people—not to be isolated within a personal office or workstation. If they are going to cocoon themselves within their own individual space, they’ll be better off continuing to work from home (especially when the kids are back in school).  Even if we give each other a few more feet of personal space, the workplace is still going to be a very risky place to be until there is a treatment or vaccine for COVID-19. There are too many kitchen counters and appliances, doorknobs, bathroom stall doors and elevator buttons to ensure that you won’t be infected at the office. In sum, we’re either going to feel safe enough to go to the office or we’re going to stay home. If the office becomes an environment where we must isolate ourselves, wear masks and gloves and avoid touching anything, the office is doomed.

With respect to office design, there is a tendency to create something new every 10 years to keep things fresh and show progress. The problem is these changes don’t work for everyone and blindly following the latest and greatest isn’t a wise path forward for every company. Shortly after much of corporate America rushed to implement the “collaborative”, open plan work environments made popular by WeWork and other tech companies, Harvard University came out with a study saying people were actually less productive and even collaborated less in these types of layouts. Further, in some cases, the personal workspaces incorporated into many of these open plans didn’t correspond with the daily work tasks of the employees; it wasn’t a good fit. Blindly rushing to make design changes to your space because of an extraordinary, and hopefully temporary, pandemic will likely result in similar problems.

Certainly, landlords and tenants need to implement new policies and procedures to ensure the health of their employees in response to COVID-19. Already, some landlords are exploring heat sensing cameras in their lobbies to detect people with high temperatures. Fingerprint scanners are being replaced with security scanners that don’t require touching and there will probably be more security guards in building lobbies to direct traffic, control density and even push the elevator buttons. These are essential to monitor and control the risks of the current health crisis and should not require material, long term expenses. There may also be more material, permanent changes made to buildings as a result of this pandemic either by reason of mandated changes in health and building codes or because they are viewed as value added features that will appeal to future tenants. For example, landlords may decide to put expensive air filtration systems in their buildings as a selling point to tenants. 

Conclusion

Any contemplated change in design or layout by a tenant should account for the fact that, like the Spanish Flu of 1908, COVID-19 won’t be around for long. When it leaves, a company’s office design and configuration need to make sense and needs to be cost effective. A blind rush to the latest and greatest could be very costly.

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How the COVID-19 Crisis Will Impact the Office Market

“Never make predictions, especially about the future.” – Casey Stengel

As we all continue our new routines working from home, many of us are wondering if this work arrangement will represent just a temporary blip on the screen or a permanent paradigm shift in the way we work. On the heels of a major catastrophe, there is a tendency to jump to rash conclusions about how we live and work.

For example, after 9/11 many people questioned whether anyone would ever work in a trophy office building again. Over time, we moderated our response and, though we took new precautions and changed our building codes, the office market ultimately returned to normal.

This time I think things will be different. Perhaps because this crisis is affecting so many of us and for an indefinite period of time, I believe there will be some meaningful and permanent changes to the way we operate our businesses and consume real estate going forward.

Here are six predictions: 

  1. More employers will adopt “hoteling.” We have certainly come to realize that a lot of the work we do can in fact be performed remotely and people like this flexibility. However, our time away from the office has also reinforced the importance of community and our need to have a place where everyone can come together. As a result, companies will balance these competing needs by reducing the number of dedicated desks or seats and creating more hoteling spaces. This will allow companies to reduce their physical footprints and real estate costs and materially reduce demand for office space in most markets.
  2. Greater emphasis on collaborative spaces. We will realize that a lot of the quiet, “heads down” work that people performed in their offices or cubes can in fact be done at home. If people can stay at home and do a lot of their work, what role or function should the headquarters space serve? Companies will start to appreciate that the headquarters is a place that people come to find community, interact with their colleagues and, frankly, get away from the isolation of home. When planning the office, the main focus will be on creating community spaces that foster this type of interaction like in co-working spaces. Likewise, landlords will continue the current trend of creating more communal spaces in their buildings so that tenants can interact with each other. Building lobbies will become town centers for the tenants designed (and tenanted) to attract people and promote interaction.
  3. Acceleration of the trend toward smaller offices. What we have been missing during this period of sequestration is social interaction. Companies are realizing that, the larger someone’s office, the less likely they are to leave it. Offices will continue to shrink in size as companies try to encourage their senior leadership to get out and interact with their people — the thing we have missed the most over these past weeks.
  4. More flexible rent structures. There are certain established customs in commercial real estate that people blindly follow because, well, “that’s the way it’s always been done.” For example, why do tenants need to pay the same rent every month with no flexibility to spread the annual obligation over the term in relation to their seasonal cash flow? Why should a bad month or two of business put at risk a 10-year lease obligation and require the tenant to beg for the landlord’s mercy, especially when the tenant has always paid its rent on time? The current COVID crisis is demonstrating the extreme vulnerability of many tenants to just a month or two of poor sales/revenues. In the future, leases will provide more flexibility to defer or prepay rent for certain periods of time. For example, tenants will have the right to defer rent for up to three months provided they post a three-month letter of credit at the outset of the lease. Lenders will need to adapt to this new reality.
  5. More spend on information technology. Bet you wish you invested in Zoom about two months ago. Well, rest assured that your company will be heavily investing in Information Technology in the months ahead as it works to accommodate the growing number of remote workers and plans for the next major catastrophe. Businesses are incredibly resilient. On 9/11, New York City lost millions of square feet of office space in a single day and yet companies reopened in hotel rooms, homes and temporary spaces within just a few days or weeks. The coronavirus was a wakeup call for many companies that they had no real contingency plans in case of emergencies. More companies will be prepared for the next crisis by relying on technology. 
  6. The independent contractor explosion. Companies are going to assess more critically the makeup of their workforce and determine who needs to be a full time employee and who can be an independent contractor engaged on a project by project or hourly basis. If someone can truly work remotely and independently, do they really need to be an employee, or can they be an independent contractor? By untethering people from the office and fixed payrolls, businesses will gain more flexibility to grow and contract their work force and also significantly shrink their physical footprints. Office space represents a bet on a company’s long-term future. If you guess wrong and have too much or too little space, it can have devastating effects on your business. By outsourcing more staff, companies will be able to shorten these bets and, therefore, reduce their real estate risk.

Conclusion. Other than the two world wars, no event in the past 100 years has impacted the daily lives and businesses of as many Americans as this pandemic. As we adjust by necessity to these difficult times, we will learn to appreciate things we took for granted only weeks ago and will also realize that it’s probably time to make some permanent adjustments to the way we conduct business. We read the tea leaves and came up with our own predictions. However, the great thing about predictions is that, a year from now, no one remembers if you were wrong.

This article was published in the Philadelphia Business Journal on April 28, 2020.

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The Looming Landlord/Tenant Divide

As recently as early March, landlords in Center City Philadelphia and the surrounding suburbs were sitting on top of the world.  They were cutting lease deals and asking for rents that were, in some cases, 30% to 40% higher than what they agreed to just a year or two earlier.  In fact, because rents were approaching replacement cost, new construction was viable.  Hamilton Lane, Amerisource Bergen and Morgan Lewis, among others, committed to major new office buildings at some of the highest rents ever paid in their respective submarkets.  Now, just a month or so later, many businesses are struggling just to survive the COVID-19 pandemic and others are wondering about the future of the office market and whether they will need nearly as much space in the new virtual business world.  When landlords and tenants get back to the negotiating tables, their respective views of the market may be miles apart.

How Covid-19 May Impact Future Demand

A lot is already being written about how our forced trial of remote working will ultimately impact office space utilization when things return to “normal.”  While some people believe that workers trapped at home will beg to return to the office once released from the government-imposed quarantine, others believe this forced exile will do to the office market what e-commerce has done to the retail market.  Make no mistake, over the long term, demand for office space will shrink.  Here are just a few reasons why:

  1. Companies will now be more willing to adopt hoteling and, therefore, no longer plan for one dedicated seat at the office for every employee.
  2. Many businesses will fail or shrink as a result of this COVID 19 crisis and their excess space will come back on the market.
  3. As companies realize that certain types of work can be done remotely without sacrificing quality, some companies will decide to outsource these functions to cheaper labor markets/countries.
  4. Co-working, the largest space consumer over the past five years, will contract in a major way.  The hyper, global expansion of this industry was not sustainable (or profitable), thousands of clients are canceling or not renewing their licenses and a lot of this space will ultimately come back on the market.

Of course, it’s important to note that when it comes to real estate, change doesn’t occur overnight.  Commercial leasing is a relatively long-term commitment and, as a result, companies may not be able to implement material changes in their space utilization until their current leases expire (or they at least get close).  Only then will they be able to shed excess space or reconfigure into more efficient space plans that accommodate the new remote work paradigms.  As a result, unless there are major business failures in the short term, it may take years for the foregoing trends to materially impact rental rates in any given submarket.

Landlords’ Perspective

Almost every economist acknowledges that we are now in a recession; however, this recession is very different.  Not only did the economy go from firing on all cylinders to a complete stop, but this change also happened overnight and without warning. No one had time to prepare for this or to adjust their expectations.  This sudden, dramatic change in the economy may create a very problematic dynamic when landlords and tenants sit down at the negotiating table to hammer out a long-term lease.

If two parties approach a negotiation with anchored expectations that are completely at odds with each other, the gap is often very difficult to bridge.  Is the office market today the same one we saw in early March 2020 when deals were being inked at the highest rents in the region’s history, or are we in a recession that will dramatically impact real estate for the reasons stated above?  Are we going to see a quick “V” shaped recovery, or will this pandemic related recession drag out for months or years and fundamentally change the way companies consume office space?  It is very likely that landlords and tenants will have (or at least express) very different views of the market when they turn their attention to leasing transactions in the coming weeks and months. 

How Will Deals Get Cut?

Ultimately, deals will be decided based on each party’s alternatives.  The more and/or better the options a tenant has, the more likely it is that at least some of the landlords under consideration will be fearful of the future and will, therefore, act aggressively to fill their vacancies while they can.  While landlords may disagree on the long-term impacts of COVID-19 on commercial real estate, any landlord who says it feels as good about the future as it did in February isn’t being honest.  The office market has a lot more uncertainty than it did two months ago.

Tenants with multiple options should be able to obtain aggressive pricing from competing landlords in the near term.  Tenants with fewer options (or who are competing with multiple other tenants for the same space), may not see the immediate movement in rents they were hoping for.   While demand for office space should decrease, it will occur gradually as leases expire, deals are restructured, and companies shrink their footprints.  We may not see the market soften across the board until landlords start getting back the excess space resulting from the COVID-19 fallout.

Conclusion

Because of the uniqueness of this current recession and the speed with which it hit us, landlords and tenants may have very different perceptions of the market and the future of commercial office space when they sit down to negotiate a lease in the coming weeks and months.  The key for tenants will be finding landlords whose view of the future is consistent with their own.

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House (Office) of Cards Awaiting With Tenant Build-Out Projects

You signed your lease in January and your current lease expires in November.  Plenty of time to design your space, pull permits and be into the new digs by mid-October with plenty of room to spare.  Everything is going great until…COVID 19.  Everything shuts down.  What happens now?

If you think about commercial leasing or even residential leasing or homebuying, they are all a series of interdependent transactions.  If someone breaks the chain, all hell breaks loose.  Think about a home buyer who needs to sell her current home in order to fund the purchase of her new home. If the day before closing, her buyer defaults, she is no longer able to complete her purchase.  Her seller may now have a problem buying his next home etc.  The same happens in commercial real estate.  When one tenants moves out, another will be moving in.  If the current tenant cannot vacate in time, that exposes the successor tenant who won’t be able to move in on time.  One holdover begets another holdover.

Luckily for the real estate world, these broken chains are usually few and far between and the impact can be mitigated through overtime workers, temporary space or even paying some punitive holdover rent.  Now, however, we’re in completely unchartered waters.  In a growing number of states, the government has mandated (or will soon mandate) the suspension of all non-life essential businesses.  In most dictionaries (and government proclamations), this does not include construction, demolition, design work or movers.  Thus, virtually every tenant buildout project is either going on hiatus or getting cut back significantly.  Inevitably, there will be an avalanche of delays rippling down the chain. 

The Potential Claims and Liabilities

Some of the more interesting questions that ultimately must be answered are:

  1. Will the tenants who can’t get out on time be treated as holdover tenants by their current landlords or, even worse, be evicted by their landlords?
  2. Will these tenants claim that COVID 19 is a force majeure which prevented them from vacating in a timely manner so that they are entitled to additional time?
  3. Is the covenant to surrender the space by the expiration date one that is entitled to the benefits of force majeure or is that risk solely on the tenant?
  4. Will landlords who are responsible for the build out of a new tenant’s space be held responsible for the late delivery of the new premises?  If they are successful, what happens to the tenant who is now subject to liability for its holdover that its current space?  Will the landlord’s defense of force majeure be used against them by their holdover tenants?
  5. How will the chain reaction be broken?  If one landlord allows its current tenant to stay a little longer, will the new, incoming tenant’s landlord allow them to stay longer (and without penalty) as they wait for their new space to open up?  What happens when one tenant in the chain is saved but another tenant in the chain is not (or refuses to defer its tenancy)?
  6. Many holdover provisions impose huge potential liability on the tenants including a multiple of their current rent plus actual and consequential damages.  The stakes might be enormous for tenants treading in these waters.
  7. These are just some of the claims and potential liabilities that await tenants and landlords in the world of commercial real estate. The longer the COVID 19 shutdown continues, the more tenants will be trapped in this very scary predicament and the more likely it will be that the dominoes start to fall.

Solving the Problems

How will commercial landlords and tenants resolve these issues which could potentially ruin already fragile companies emerging from the COVID crisis? In the ideal world, all parties will play nice in the sandbox and make accommodations for their counterparts.  However, that is unlikely to work in all circumstances.  It may very well require legislation which puts a temporary moratorium on any eviction or holdover claims, much as the federal government has done with foreclosures and some residential evictions.

While we are waiting to see how this all plays out, tenants should get their lease documents out and have their advisors review the relevant provisions including, surrender, holdover, force majeure and tenant work letter/tenant build out.  It may be that the language addresses some of these issues.  If not, tenants need to know what their exposure is.  The best tact is to identify the problem as early as possible in the process and start a dialogue with your landlord(s).  If you believe you will be late in vacating your existing space, you may be able to get a short term extension from your landlord assuming they have not yet leased it (or the next tenant doesn’t need immediate possession).  If they have leased the space but the incoming tenant has enough advanced warning that it won’t be able to possess the space on time, it may be able to get a short term extension from it’s landlord thereby relieving the time pressure.

Conclusion

The COVID 19 crisis has brought forth a slew of new and unanticipated problems for businesses to deal with.  Delays now piling up in world of tenant construction projects is one more.  As so many lease transactions are ultimately dependent on the ones before and the ones after them, these chains are only as strong as its weakest link.  Read your lease and be prepared.  And maybe hope for some legislative help.

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The Best Approach for Negotiating Rent Relief With Your Landlord

Over the past week, we have had numerous conversations with tenants and landlords about the COVID 19 pandemic, its impact on businesses and how landlords and their lenders will deal with tenants’ inability to pay rent.  In these challenging times, we have been heartened by the empathy and compassion shown by several landlords.  Just yesterday, a landlord told us: ”Our current position with all tenants that may be effected by a temporary shutdown of business is for them to make rental payments as their cash flow allows. We will not charge late fees or interest on missed payments and will create a payment plan when things stabilize.”   

While not all landlords are able to allow these types of concessions, some are.  These are unique times and most landlords are rational entities.  Landlords will only take legal action against a tenant if they believe they will be better off by doing so.  However, in light of the COVID 19 outbreak, most landlords realize that most tenants are in the same situation—especially now that most businesses have been ordered to shut down.  Landlords and their lenders need to take the longer-term view and do what they can to ensure their good tenants remain viable. 

Given the foregoing, here are the keys to a constructive rent adjustment conversation with your landlord: 

1.  Be honest and open about your situation.  Landlords would quickly be out of business if they granted rent relief to every tenant that wanted to lower its rent.  Be prepared to explain and document your cash flow situation and why you will not be able to pay rent (or how much you will be able to pay). 

2.  Be clear as to the specific relief you are asking for.  Are you asking for rent forgiveness, a rent abatement or a deferral until things get better?  Again, tie your request to your specific cash flow situation.  A plan that shares the burden between you and the landlord is going to be more warmly received as they have bills to pay as well. 

3.  Articulate why this is a temporary situation and your plan for getting back on your feet.  The first part is easy today given what’s going on in the world, especially if you otherwise have a good history with the landlord of paying rent in a timely manner.  Again, most landlords understand that it’s unlikely any replacement tenant will be stepping up any time soon to replace you.  Your job is to convince the landlord that investing in you over the coming weeks/months will provide a better return than if they replace you. 

Conclusion 

We are entering unchartered waters here and deals will be cut between landlords and tenants that would not have been considered just a month ago.  It is always important to remember that people usually act in a financially rational manner.  In most instances, sticking with their current tenant is going to be the best bet for landlords.  In approaching your landlord, be honest, respectful of their situation and creative.  In the end, to paraphrase Mick Jagger, while you might not get what you want, you may get what you need. 

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Coming to the Office or Working Remotely: What’s the Future?

There are two significant, and seemingly inconsistent, trends taking place in the office world right now and how this battle shakes out may ultimately dictate the future of the workplace as we know it. 

On the one hand, a greater percentage of the workforce than ever before is asking for the flexibility to work from home. On the other hand, there’s a growing segment of the workforce that is tired of working from home and are flocking to co-working spaces. 

How then do we reconcile these two seemingly conflicting trends? Is it simply a matter of “the grass is always greener” or is there something much larger and substantive taking place that goes to the essence of what it means to be employed? 

Coming to the office or working remotely

“They say on your deathbed you never wish you spent more time at the office — but I will.” – Michael Scott, The Office

As a species, humans generally crave social interaction. That explains the coworking explosion.  As we increasingly isolate ourselves within our homes with the proliferation of home delivery services from Amazon to Grubhub, we necessarily frustrate our natural instincts for human contact. Coworking companies are filling this growing void by creating a sense of community for an entire class of workers who never had this option before.

Members of these coworking establishments believe that their work lives are richer, more fulfilling and more productive just by being there.  That’s not always the case with today’s corporate offices, however. Despite the extraordinary amounts of money that many companies are spending to create edgy, open planned environments that mirror the coworking aesthetics, in many cases these organizations have failed to replicate the sense of community that makes people want to come to the office.

Workers are finding that a growing percentage of their daily tasks can be performed remotely. If they are going to sit in their chair and write reports, analyze data or draft a brief without much face to face interaction with their co-workers, can’t they do it from home without losing commuting time, paying city taxes (assuming they commute into the city for work) or dealing with the distractions of a noisy office? 

The answer is “yes,” and this answer is going to apply with greater frequency as technology continues to advance. As a result, if companies want their people to come to the office, they’re going to need to create a sense of community and a corporate culture that makes people want to come to work.

A culture is established through behaviors, not drywall, millwork and furniture. The following example illustrates this point.

A while back we toured a client’s newly constructed headquarters space. One of the senior executives walked us through a very nice employee lounge area adjacent to the executive suite that was furnished with soft couches, rugs and a large screen TV. He stopped in front of the space and said, “This was a big waste of money. No one uses it.” We asked him if he and the other senior executives used this area. He said they did not because they were too busy. We pointed out that if employees don’t see the senior executives using the lounge and think it’s viewed as a place where people go when they don’t have enough work to do, employees aren’t going to use it.

The senior executives unknowingly created a corporate culture that discouraged their people from hanging out with each other in their new, expensive lounge. If they really wanted people to use the communal space and promote a culture of social interaction, the executives needed to lead by example. Instead, people were staying at their desks – a work experience they could replicate from home.

What can companies do to create compelling workplaces where people want to be? 

Again, important lessons can be learned by looking to the coworking industry. A young accountant may go to a coworking location because it exposes her to a whole ecosystem of entrepreneurs, small businesses and other professionals who represent potential clients. She’s much more likely to get new business by coming to the office than if she stayed home. Coming to the office is a good business decision.

In sum, people will choose a behavior if it is economically rational or enjoyable. Likewise, companies need to create opportunities within their offices for their employees to grow and advance professionally and personally. They also need to make their employees feel like they are an integral part of something greater by building a brand that they can relate to and be proud of. Too often we see shiny, new office spaces that could belong to anyone. The space does not reflect the values, culture or history of the company that is housed there. It doesn’t compel anyone to be there because it doesn’t feel uniquely theirs.

The impact of COVID-19

“An office is a place to live life to the fullest. To the max. An office is a place where dreams come true.” – Michael Scott, The Office

The remote working phenomenon is going to be pressure tested in the coming months as we deal with the COVID-19 outbreak. Companies who previously resisted the work from home paradigm are now being forced to implement it. Hopefully the need to accommodate the effects of COVID-19 will be a short-term situation. However, what happens if six months from now, companies see that they received good production from their employees who were not in the office and the employees are now used to working remotely? Will employers embrace this arrangement and start to reevaluate how much office space they really need?

Alternatively, if the employers believe a physical presence in the office is essential to sustain their corporate culture, they will need to work even harder to draw their employees back to the office.

Conclusion

The future of the office workplace is in the balance as technology and now COVID-19 enable or force us to work remotely. If businesses are to preserve their cultures and ensure employee loyalty, they are going to need to provide more compelling reasons for people to come to work.

This article was published in the Philadelphia Business Journal on March 18, 2020.

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