Knowledge, Leverage, and Opaque Markets
An office lease is a unique financial transaction. While supply data is widely available, the values associated with completed leases are not so readily available, nor is the financial position of the landlord and its partners. In effect, despite the preponderance of available data in residential markets (e.g., Zillow, etc.), office markets remain opaque. The educated occupier can certainly access more information today than in decades past. But it’s not enough to merely know available spaces. Achieving a complete understanding of the markets can only be accomplished by partnering with a firm which is engaged in the market in a variety of very specific contexts. You need an intimate understanding of landlord motivations, capital structures, and even the intricate dynamics of tenants within a building. Yet many real estate service firms don’t have this information because they lack the practice groups.
Let's break this down. Why should you, an occupier, care about the landlord's capital market strategy? In one word: leverage. By understanding a landlord's motivations, strengths, and weaknesses, an occupier gains an upper hand in negotiations. Such knowledge which can only be gained by being active in the markets – by having access to offering memorandums (“OMs”) and other data-rich sources that reveal the landlord’s investment thesis, its capital structure (debt and equity) and the unique tenant dynamic within the building (lease rollover, transaction values, etc.).
Similarly, you might wonder how investor (landlord) advisory helps the tenant advisor achieve better results. It’s because a robust landlord advisory practice creates a trove of data that is otherwise not available to firms who lack such a practice. Included in this data are “lease comparable” showing the complete details of transactions completed.
Securing the right office space isn't just about the art of the deal. It's about aligning the property with specific business goals. From fostering employee well-being to ensuring optimum productivity, the right office can be a catalyst for achieving broader organizational objectives. Knowing what you want—be it a certain location, design, or cost—is paramount before even setting foot in the market. Only after defining the target outcomes should companies embark on identifying site options. Importantly, prospective sites must also be evaluated based on landlord motivation (debt and equity), leverage dynamic (lease roll, etc.), cost basis, quality of amenities, quality of management (tenant experience) and many other factors.
The gap between a landlord's initial offer and the final deal can be vast. This gap is where occupiers can harness the power of competition. When multiple landlords compete for a tenant, businesses have the advantage. The more landlords compete, the more an occupier can flex its leverage to meet their leasing goals at an attractive price.
Our role as the tenant advisor is to structure this competition in a manner which maximizes the extent to which landlords compete, thereby enabling our occupier client to meet its leasing objectives at the lowest possible cost. And this dance of negotiation isn't random; it's a choreographed performance, managed meticulously with requests for proposals (RFPs), comparative analyses, and subsequent structured negotiations. Proper time must be given to allow this process to be fully realized (often providing for several rounds of negotiation), including protecting back-end schedule which is reserved for planning and construction.
This is how we “leverage” the market. Leverage, however, is only as strong as the knowledge and timing that backs it. When properly deployed, leverage has a massive effect on quality and cost. With office markets under intense pressure from hybrid and remote work setups, this is a uniquely favorable time for occupiers to negotiate office leases. But tread with caution: going solo without an advisor can prove costly. With so much fluidity in the markets, we are seeing a broad range of leasing outcomes, from good to bad. The worst results evolve when occupiers choose to negotiate without an advisor. This is often done with the assumption the leasing fee the landlord would otherwise pay will be available as an additional concession, applied for the benefit of the tenant. However, this is highly flawed logic. Firstly, many general partners keep the entire fee for themselves when they avoid having to pay a 3rd party broker – the fee is not eliminated or redistributed to the tenant, it’s kept by the landlord operating entity. Secondly, the value of a leasing fee should represent a small percentage of the value created by a good tenant advisor. For example, the fee on a 5-year lease of 10,000 sf in San Francisco would be $150,000. Yet a good advisor, by accessing critical data (e.g., lease comps, investor data, etc.) and running a strategic process to access leverage, can easily facilitate an extra $20/sf in landlord-funded concessions, and reduce rental economics by 15% (say from $75/sf to $64/sf). The value of the concessions is $200,000 and the value of the lower rent is $550,000. Hence the fee is just 20% of the added value derived by engaging the tenant advisor. Most importantly, in San Francisco, the tenant advisor’s fee is paid by the landlord, in any case. In the end, when occupiers negotiate without proper advisory, they fail to access critical leverage and pay significantly more.
Office markets will continue to be largely opaque to occupiers. A well-chosen advisor will bring knowledge to bear and create leverage which will drive value. This is a great time for occupiers to achieve long-term savings, but good advisory will make all the difference.