Commercial real estate has never been more important.
That might sound counterintuitive given the unprecedented shift to remote work we saw due to the COVID-19 pandemic. Offices emptied, and companies discovered they could make do without them — at least temporarily. However, keep this in mind: Companies might need less square footage than they did before; many people will continue working remotely after the pandemic; the idea of shared workspaces will never be the same again. But that doesn’t make workplace strategy any less relevant to a company’s success.
Let’s run through an example. Many commercial spaces aren’t working as intended because they no longer meet the needs of staffers looking for a flexible work situation or enhance a company’s ability to attract talent. Every indicator suggests companies are reevaluating their office footprint, but that raises a host of difficult questions: How much space is necessary? What’s the ideal location? Which amenities are most important? What’s the market price point for rent?
With office vacancies not predicted to return to peak pre-pandemic levels until 2025 and commercial landlords more willing to negotiate lower rents, there’s an unparalleled opportunity to find a great deal. Unfortunately, the right location doesn’t have a massive arrow above it. Great locations take a lengthy search to find, and there are unmistakable consequences for choosing the wrong one.
Regardless of whether corporate occupiers are upsizing, downsizing, switching locations, or rethinking their existing ones, commercial real estate will be an important subject in the coming months and years. With that in mind, here’s everything you need to know about developing a commercial leasing strategy that truly works.
Planning for Growth: It’s Time for a New Commercial Real Estate Strategy?
The most obvious sign that it’s time to seek out new commercial real estate is having more staffers than space to seat them.
During and after the COVID-19 pandemic, however, other concerns might necessitate a move. Your company might need a space that allows for social distancing or serves as a gathering space rather than a sea of cubicles. Leadership might see better opportunities to expand to new markets to attract customers or staff members located elsewhere. Or your firm might need a space that’s smaller or less expensive than what you currently have. All these reasons and more will result in a wave of relocations and portfolio rebalancing in 2021 and beyond.
Your company’s key players in real estate planning should ask themselves this question: What’s the primary goal of our leasing strategy, and does our current real estate portfolio serve that strategy?
Don’t expect an obvious answer. Instead, seek input from throughout your company to help the real estate team make the right choice. Ask the C-suite what image it wants to project through real estate and how much money there is to spend. Consult with HR about what the staff needs in terms of space and personal work preferences. Ask IT what technical requirements an office, warehouse, or store must have, especially as technological needs morph and grow. In short, gather input from all business unit leaders so no detail or requirement is overlooked when it comes to your commercial real estate space requirements.
The next question is this: What’s the minimum square footage we need for office space? The answer requires a close examination of what the on-site team looks like at this point. How many people come into the office regularly? Do they have dedicated desks, cubicles, or offices? Are people meeting in groups, and do those groups include clients?
Figuring out what’s necessary and what isn’t gets a company closer to the right number of square feet. However, as a general rule of thumb, plan for 150 square feet of space for every on-site employee. By this calculation, for instance, a company with 70 employees will need 10,500 square feet of office space. However, if half the employees work from home at any given time, a 5,000-square-foot office could provide plenty of space at a decidedly better cost.
The key to fine-tuning your commercial real estate strategy to the needs of a company operating in a fast-changing economy will be asking the right questions and then spending enough time exploring the answers. Here are some great prompts to start with:
- Where do employees commute from?
- Where are clients located?
- What are the current market rents and concessions?
- What type of building is necessary?
- What building amenities are necessary?
- How long does the lease need to be?
- Is building a space an option, or does the space need to exist already?
- What location draws will attract and retain talent (think restaurants, coffee shops, stores, and so on)?
- Similarly, is there close proximity to public transportation?
- Are there flexible space operators (such as WeWork) in the area that allow more freedom than a traditional lease?
- What ratio of remote-to-in-person working time do employees prefer, and what kind of location will be most convenient for that?
- What technology is required to support a mobile workforce, and what investment is necessary?
Once you’ve answered these questions, you reach the more difficult part: finding a space that checks all the boxes. That’s where a commercial real estate broker— specifically a tenant representative — comes in.
Making the Most of a Tenant Representation Broker
Brokers can be an asset to any company rethinking its commercial real estate strategy —even if there’s a dedicated real estate team in-house. That’s because commercial real estate brokers (also known as tenant representation brokers) have extensive market expertise, especially in markets where a company might be new and unfamiliar. They know the ins and outs of leasing in a particular building or neighborhood better than anyone else, which makes it faster to find commercial real estate that supports the needs of your business.
And even though commercial real estate brokers make moving more successful, they also do the same for staying put. When it comes time to renew a lease, a broker can help a company secure more favorable terms — especially in a depressed commercial real estate market where landlords are eager to keep tenants around or are desperately trying to fill vacancies. Working with a broker might lower the price of staying so much that it’s financially viable to renovate the space or seek out supplemental locations rather than moving everyone out.
Whether you’re relying on a broker to stay or go, the savings you can arrange by negotiating or renegotiating lease terms almost always outweigh a broker’s commission fee. Be aware that broker’s fees for both the landlord and the tenant are often built into pro formas and listing agreements, too. If the tenant fails to utilize a broker, the fees allotted for that purpose go to the other broker or the landlord. Given this fact, the return on investment of working with a tenant representation broker is very compelling.
However, the most compelling reason of all to bring in outside help is because of the access brokers have to insider information. Brokers subscribe to expensive databases such as CoStar and LoopNet, and they often know about off-market opportunities that would be invisible to tenants trying to find commercial real estate on their own. While transparency into commercial real estate data has increased in recent years, we’re not yet at a point where availability data is public and accurate. So beware of the Google search for “office space” and the reliability of the results.
Valuable as brokers may be, they’re not all created equal. When searching for the top tenant rep brokers, ask these questions about your list of candidates:
- How do they communicate and collaborate with clients? Do they use technology, or are they relying on antiquated methods?
- What past deals have they completed that are relevant to this one?
- What additional resources do they bring to the table that are relevant to this one?
- Will they get along with your culture and team?
Enlisting a broker is a great decision, especially when you find just the right one. However, making the most of the relationship also requires a shared understanding that’s difficult to establish with just phone or email. Having a shared platform to work on gives the broker and you — the corporate occupier — a single source of truth.
When everyone has a complete set of facts and information at their disposal, it eliminates misunderstandings and duplicated work while streamlining the decision-making process on both ends. Why use a commercial real estate broker if the partnership can’t be maximized? After all, a shared platform makes a good process great.
Leasing 101: Common Commercial Leases
Having the right lease matters just as much as having the right space.Your company should decide for itself — hopefully in consultation with a broker — what kind of lease you need and what the most favorable terms look like. There are many different types of commercial lease agreements, but the most common options include:
- Short term (one to three years): The advantage of a short-term commercial lease is the flexibility to leave in a short period of time without paying a penalty. But this option might cost more and be harder to find as landlords generally prefer to have tenants commit for longer time periods. The good news is that there are plenty of flexible space operators out there that specialize in this type of lease.
- Standard term (three to five years): This lease is the standard because it’s often the best option for tenants and landlords. The length of time offers some flexibility at a competitive rate. And by committing for a bit longer, tenants make themselves eligible for concessions like buildout allowances or free rent — especially with a broker as an advocate.
- Long term (five or more years): A long-term commercial lease might allow you to achieve the best rental rate, but your flexibility is limited, and you’re typically paying for significant capital expenditures out of pocket. Typically, this option works best for companies with a clear vision of the future and the capital necessary to provide a long-term home for their employees.
Whether for office, retail, industrial, or mixed-use spaces, there are a few other types of commercial leases worth considering:
- Full-service lease: The tenant pays the landlord to handle all or most of the expenses related to a property (think taxes, maintenance, insurance, and so forth).
- Net lease: The tenant pays a lower rental rate to the landlord but also pays out of pocket for services such as trash removal, landscaping, parking lot repaving, or whatever conditions the lease terms stipulate.
- Modified gross lease: Somewhere between a full-service and a net lease, a modified gross lease involves the tenant paying the landlord for rent and select services charged and recalculated on an annual basis. Some fixed costs, such as electricity, are explicitly stated in the lease.
- Co-working lease: This is a kind of short-term commercial lease agreement with a high degree of flexibility. Companies can access highly customized spaces but at a premium price.
- Percent lease: The tenant pays a base rent plus a percentage of monthly sales. This type of commercial lease agreement favors the landlord and is commonly imposed on shopping mall tenants or businesses with high sales volume.
In any lease agreement, however, certain tenant rights should be nonnegotiable. These include the right to renew the lease, which gives a business the right to stay in a quality location for as long as the lease stipulates and avoid the disruption of a sudden move.
Alternately, tenants also need the right to terminate a lease and leave a space, ideally with the least expense and inefficiency possible. And when termination isn’t possible, tenants need the right to sublease commercial space to recoup some of their costs. They should also have the option to occupy more space within a building when possible and necessary with preference over outside tenants. Finally, the ability to restructure a lease agreement makes a commercial real estate strategy flexible in the face of the unexpected (such as, say, a pandemic).
Speaking of the pandemic, COVID-19 altered expectations around commercial real estate in ways that every tenant needs to be aware of. Before, flexibility wasn’t a strong feature within lease agreements. That’s changing now that companies are shifting to remote work, thinking differently about work-life balance, and trying to outpace the competition in fluid markets. Expect to see landlords offer more short-term, co-working, or gross modified lease options as tenants increasingly demand more flexibility. Post-pandemic, commercial real estate can’t limit your company’s agility. It must enable it by allowing your organization to scale, move, and adapt to spaces with ease.
Lease Accounting in a New Era of Commercial Real Estate
Recent changes to lease accounting standards add yet another wrinkle to today’s commercial real estate market. Before diving into the details, however, let’s review the two major types of commercial leases:
- Capital lease: Similar to owning a piece of property, a capital lease appears on a company’s balance sheet. Interest payments on debt financing go on the income statement, the present market value appears under the assets side, and the loan amount is included under liabilities.
- Operational lease: Similar to renting a property, lease payments are accounted for as operating expenses on the income statement. That’s the extent of the accounting requirements.
New lease accounting standards (right now, that’s FASB ASC 842 and IFRS 16) change how companies must account for lease payments. With the exception of short-term lease payments, all leases must now appear on the balance sheet as a lease liability and right-of-use asset. The distinction between capital lease versus operating lease no longer matters from an accounting standpoint, which eliminates some ambiguity but also makes lease accounting more complicated overall.
FASB ASC 842 also requires companies to separate leases embedded in contracts. For example, if a contract includes stipulations around leasing equipment for manufacturing, leasing servers for IT, or leasing billboards for advertising, those agreements must appear on the balance sheet as well. Accounting for commercial real estate leases now requires more input from staff and more time in general.
Making matters worse, companies must comply with another update that affects lease accounting. Known as IFRS 16, this lease accounting standard works similar to FASB ASC 842 in that it creates a single accounting model to recognize assets and liabilities from all leases. But there are also differences between the two standards. Without getting into the weeds of how they deviate, the fact is that companies must comply with two sweeping and separate rule changes that make lease accounting far more challenging than before.
As you revise your commercial real estate strategy moving forward, then, you should be aware of these changes and put the right policies in place to comply with them. Accounting violations can have expensive, lasting consequences, so it’s ideal to avoid them at all costs. A shared platform for real estate data can both help with long-term compliance, as can the best practices we’ll outline in the next section.
Best Practices for Lease Management
When so much depends on your company’s real estate portfolio, it requires careful management and oversight. We’ve mentioned the importance of partnering with commercial real estate brokers. But internally, there also need to be partnerships between your back and front offices as well as between your real estate team and other stakeholders throughout the organization. After all, everyone has a stake in where your company operates. Therefore, everyone should have some input.
Best practices around commercial real estate management all relate to keeping various stakeholders coordinated and in close communication. All the potential problems — from choosing the wrong space to violating lease accounting standards — result from a misalignment between different moving parts. Knowing that, the single best practice your company can follow is to integrate everyone and everything relevant to your real estate portfolio in one place.
A single source of truth can save you time because no one has to wait to get the information they need. It can also eliminate errors that arise from miscommunication or bad data. Most valuable of all, a communal data resource synthesizes the three pillars of a corporate real estate strategy: transaction management, lease administration, and lease accounting. Best practices really boil down to keeping everyone on the same page, and today’s lease management software makes that easier than ever.
A Tech-Driven Corporate Real Estate Strategy
Technology can make commercial real estate manageable — even as it becomes more complicated and a higher-stakes endeavor. There are a number of cloud-based “proptech” solutions on the market, for instance, that are of varying quality. In your hunt for helpful tools, look out for these features to dig up the best options:
- Simple: From beginning to end, commercial real estate deals consume massive amounts of time, enlist multiple stakeholders, and generate huge volumes of data. Lease management software should make everything easier by simplifying, expediting, or eliminating work that would otherwise have to be done manually. Look for solutions that promise clear, substantial ROI in terms of time saved, costs avoided, and so forth.
- Collaborative: In a future driven by remote work, any proptech platform worth its salt needs to integrate stakeholders across various locations. Hosting data on the cloud helps with accessibility, but the solution itself should facilitate collaboration by moving more data into the right places automatically instead of letting it get lost in spreadsheets or PDF files. Look for solutions that help your real estate team and everyone they rely on work in perfect sync.
- Secure: When commercial real estate software becomes a single source of truth for all relevant data, it also becomes a valuable target for hackers. And when there are multiple people, locations, networks, and devices involved, the risk of a successful attack is high. With this in mind, always look for solutions that can support a single sign-on and include multiple data protection capabilities.
Why Business Success Depends on Having the Right Approach to Commercial Real Estate
Because it’s now directly related to business success, your commercial real estate strategy has never been more important.
Of course, the two have always been linked. But never has your company’s fortune depended more on its footprint, lease obligations, and accounting standards. You need the right commercial real estate portfolio to help with this. Just as important, you need to manage that portfolio effectively in the face of positive, negative, and surprising circumstances.
A lease management platform improves all major parts of the process: broker relationships, site location, lease negotiations, lease accounting, and so much more. And as commercial real estate becomes more complex, consequential, and competitive all at the same time, it risks becoming a liability. Great software keeps that from happening and does just the opposite: It transforms commercial real estate into a strategic asset and a driver of business success.
Occupier leads the way in this new era of lease accounting and lease management. Schedule a demo to chat with our dedicated team and see what a better approach to corporate real estate management looks like.