2023 Archives
TenantSee Weekly
Pandora's Office: Part IV - Wearable Work
Today, we examine the transformative role of Artificial Intelligence (AI) and automation in the workplace. AI will have broad impacts on work in the information economy, both in how and where work is done. While it's true AI and automation could lead to significant job displacement, it’s also true that AI will create new jobs. Studies suggest that AI will affect job transformation more than destroying jobs, altogether. It automates parts of jobs, not whole jobs. The nature of some roles may change, requiring a focus on skills that AI can't replicate – creativity, critical thinking, emotional intelligence, and complex problem-solving. For those at the top of the food chain, this shift will make jobs more strategic and rewarding, enhancing employee engagement and productivity. Yet jobs at the lower end of the white-collar spectrum will be susceptible to displacement.
In the context of place, as in office space, AI is emerging as a valuable tool for management and optimization. Intelligent systems are being deployed to monitor and analyze occupancy and spatial data, enabling real estate managers to maximize space usage and minimize waste. These systems can also contribute to making office spaces safer and more comfortable, by monitoring environmental parameters and automating adjustments to lighting, temperature, and air quality. Yet just as many CRE managers are becoming aware of specific use data, they find themselves navigating an interesting paradox; namely, those same individuals not using their designated office space are reticent to give it up. In the end, we believe the data will win. Faced with the cold hard facts of wasteful office spend, companies are increasingly shifting space requirements to accommodate the use case, not headcount. The net effect has been profound in terms of the amount of space leased. Consider that pre-pandemic, a company having 100 people in a region would have sought space for 100 people (plus some amount for growth). Today, this same company will look at actual use and craft its strategy, accordingly. It would be typical for this company to find that 30 of its 100 regional employees use the office. Adjusting the space need to solve for 30 vs. 100 results in a 14,000 SF decrease in the amount of space leased, from 20,000 SF to 6,000 SF (assuming 200 SF/employee).
Change has begun to play out across global real estate markets, with evolving demand resulting in less need for large, centralized offices designed to house individual workers. Instead, we’re seeing increased demand for smaller, flexible spaces designed to facilitate collaboration and social interaction. Commercial real estate developers are investing in smart technologies to create adaptive spaces that can cater to the changing needs of businesses. AI will bring to the office product a level of data feedback which is not unlike the revolution in wearable sportswear tech. Wearable buildings.
As companies plan a return to the office, they’re relying on AI to make this transition smoother and safer. Technologies like AI-powered health screening, touchless interfaces, and automated cleaning systems are being implemented to ensure a safe working environment. Moreover, AI tools are helping in managing schedules and coordinating office days for employees in hybrid work models.
Real estate is expensive. Historically, it was more difficult to ascertain the efficacy of this spend. Today, AI is making it easier for corporations to assess the productivity of their real estate spending, resulting in net reductions to the amount of space leased. Employers and employees, alike, must embrace the new realities of hybrid and remote work, of the transparency of data and all that it informs. The physical places we design for work must evolve to serve a new purpose which is less about individual workspace. In the end, AI will make our offices more intentional and purposeful, more valuable.
Pandora's Office: Part III - Decoding Productivity
Productivity. The backbone of a company’s success. For decades, productivity has served as a key determinant of growth and profitability. Measuring productivity, however, is a different beast. Amid the shift towards remote working, understanding productivity dynamics in both office-based and work-from-home environments has become increasingly pertinent. Unfortunately, the idea of productivity has become one of the battle grounds on which the fight over RTO is being waged. Too often, companies and employees point to misleading and/or ill-defined measures of productivity as evidence their view is right. It’s important to be fact-based and sober in assessing productivity.
Conventionally, and ubiquitously, productivity has been measured in its oversimplified form: the amount of work produced divided by the number of hours put in. Sounds simple. While this measure of productivity may be useful in a production plant, white-collar outputs and inputs vary significantly from their blue-collar counterparts. Moreover, the traditional 9-to-5 office structure has given way to more flexible arrangements, making the mere count of hours worked or tasks completed a less reliable productivity measure.
The indicators of productivity have evolved. Businesses now assess productivity through metrics like customer satisfaction levels, peer reviews, or task-specific key quality indicators. Employee engagement plays a pivotal role as a productivity indicator. Businesses routinely use pulse surveys and 360-degree team feedback tools to monitor engagement levels and correlate them with productivity. Having candid 1:1 conversations about internal and external processes, as well as discussing relationships with other teams can prove to be an effective way to evaluate any immediate or long-standing issues.
Additionally, the impact of mental health and employee well-being on productivity has led businesses to implement employee assistance programs, mental health days, and wellness initiatives. The uptake of these initiatives is monitored, serving as an indirect measure of productivity.
The role of technology in measuring productivity has also become crucial. Businesses rely on time tracking and project management tools, AI-powered applications, and cloud-based platforms, all of which provide valuable data for measuring and enhancing productivity. Advanced analytics from these tools help to identify productivity patterns, bottlenecks, and potential areas for improvement.
Deciding upon the right objectives from the myriad of feasible objectives can be overwhelming. To ensure the objectives truly resonate with the productivity needs of the organization, a company should evaluate its current performance, pinpoint areas that need improvement, and identify what success looks like in each of these areas. Moreover, companies should consider the perspectives of different stakeholders - employees, management, and clients - to create an inclusive, well-rounded set of objectives. The more puzzle pieces you have, the easier it will be to highlight pressing issues like disengagement, siloed teams, or an excess amount of admin work that keeps your teams busy without contributing to the broader business goals. Periodically revisiting and updating these objectives is essential to accommodate changing circumstances and ensure the productivity strategy remains relevant and effective.
Measuring productivity is a nuanced process that demands a delicate balance between hard data and softer insights. By acknowledging and addressing both the measurable and immeasurable elements of productivity, businesses can effectively gauge and improve productivity in this new era of work. Remember, it's not just about how much is being done, but how well it's being done and how employees are feeling in the process.
Pandora's Office: Part II - The Psychology of Workspace
One of the positive outcomes emerging from a more holistic contemplation of work is a better understanding of how the behavioral and design elements of the workplace impact well-being, the psychology of the workplace. Historically, the physical office and the culture that accompanied it, was largely a one-size fits all, top-down dictate that employees were not encouraged to question. While this one-dimensional approach may have been easier to conceive, it had the detrimental effect of failing to adequately support some percentage (maybe a large percentage) of the employees. But it’s a new day, a time when we have increased awareness of neurodiversity and sensory processing, an opportunity to provide optionality in support of the broad spectrum of employee (human) differences. It’s a moment when we can more fully contemplate the psychology of the workplace. Indeed, the more thoughtful we are in creating workplaces that cater to diverse employee needs, the better these environments will serve the organization.
How are employees diverse? Well, in the same way people are. Upon entering an office, we don’t suddenly shed our true nature. It’s unrealistic to expect, for example, a person who is highly sensitive to ambient noise to thrive in an open-desk configuration. In thinking about its employees, companies should assume their workforce is comprised of the full range of human personalities and behavioral nuances. We’re all different and we’re all doing things differently.
Let’s look at some of specific ways in which the psychology of the workplace can be enhanced through design. A well-designed modern workplace offers a variety of spaces for individuals to work, including spaces for quiet work, spaces for teams to collaborate, spaces for people to learn together, spaces to express corporate culture and spaces to meet with and entertain clients. Color is important. Soothing color choices are generally preferred over bright colors. Materials matter. It has been shown that we respond better to the elements found in nature, materials like wood, stone, even water features have a positive effect. Of course, the best light is natural light, and the best air is that which is let in through an open window. Workspaces that empower employees to customize their space enhance their sense of belonging. This may be in the form of adjustments to ergonomic furniture, lighting, or climate controls.
From a behavioral perspective, consistent application of corporate behavioral guidelines is the single most important thing a company can do. Leaders should exemplify the guidelines they give to the employees. For example, if the hybrid policy is for the team to be present 3 days a week and remote the other 2, leaders should strive to maintain this same schedule. Alternatively, when these leaders are in the office 5 days a week, those on the team who have chosen to be there only 3 may feel they’re being penalized for doing so and/or may perceive less opportunity for advancement, because others have chosen to go in 5 days a week to gain access to leaders. Employers lose when they choose behaviors that reduce employee engagement. While it’s good to have ambitious employees, those willing to sacrifice work flexibility to advance their career, it’s also likely some otherwise valuable employees have chosen the flexibility of the hybrid schedule because it best suits their particular needs. In fact, some of these employees may offer a much bigger contribution than those who are merely ambitious. When there is alignment between the company’s policy, leadership’s behavior and the behavior of the employees, good things happen. Consistency is also vital in the context of DEI initiatives. In simple terms, companies must “walk the walk”. Too often, we talk about the importance of diversity in our workplaces but fail to translate it into tangible actions that encourage and support diversity.
This is the right time to think about the psychology of the workplace, the psychological impact of the work environments we create. Here, again, such focus may reshape our perspectives on initial investments of the space we lease, or the furniture we buy. It may cause us to see inconsistencies in how we “live” our cultural guidelines. Most of all, the creators of workplaces who have a pulse on their psychological implication will win. They'll attract premier talent, cultivate better culture, and engage their employees more fully.
Pandora's Office: Part I - Cost vs. Value
In this first issue of our series, “Pandora’s Office”, we explore a fundamental paradigm. Cost. Expense. Historically, for most companies, this has been among the top factors defining how office space was chosen. In all be the rarefied air of tech and high finance, companies must generally be smart about allocating a portion of their budget to real estate spending. But when the emphasis veers toward achieving the lowest possible cost, the result is often a suboptimal facility, an investment that yields a limited return.
Let’s unpack this a bit. Today, the definition of 'workplace' extends far beyond the boundaries of physical office spaces. In fact, the word ‘place’ now seems almost redundant in this term, as technology sweeps over as a colossal contributor to the modern-day workplace, eclipsing the importance of physical spaces. For some, leasing office space has become a vestige of the past.
But for those who discern that a company-provided physical space is integral to their workplace, a shift in mechanism becomes imperative to analyze how this physical entity contributes to the organization's heartbeat and, consequently, its return on investment ("ROI"). By viewing the space through this lens, the spotlight shifts onto profit instead of cost. Why engage in real estate, after all, if it does not propel your company towards greater profitability?
The question that now emerges is: How do companies navigate this shift? For starters, they must have a clear understanding of the profit-oriented objectives they seek to fulfill through the investment. These can be numerous and varied, but in our experience, they nearly always include the following:
Team Building and Collaboration
Culture Building
Mentorship and Learning
Brand Building
Client Interactions
Assessing the real estate expenditure in the light of its potential positive influence on these key aspects creates perspective. This perspective facilitates better, more intentional decisions. Imagine the difference in outcome when a physical space is chosen based not on the price tag it carries, but on how it will serve these specific objectives. Every facet of the space, from its location to its design, will be decidedly aligned with the right objectives, culminating in an environment in stark contrast to one chosen primarily for its cost-efficiency.
It's crucial to weigh the cost alternative, exploring the potential consequences if the company refrains from the investment or curbs costs. The intangible cost of cutting costs. While the aim is to improve efficiency and conserve resources, the repercussions of these actions can often have unintended, negative consequences:
Hidden costs: Companies choosing remote work may need to invest in digital infrastructure and providing their employees with ergonomic furniture, high-speed internet, and necessary hardware.
Employee Wellness and Mental Health: On a more human level, remote work can contribute to feelings of isolation and disconnect among employees, potentially impacting mental health and team cohesion. While these costs may not be directly financial, they can indirectly impact a company through decreased productivity and increased staff turnover.
Increased Employee Expenses: While many employees may save on commuting costs, remote work can also increase their personal expenses, such as utility bills and home office equipment. Some businesses may choose to offer stipends to help cover these costs, which would then be an additional expense for the company.
Commute: Employee commute times represent an indirect cost to companies. Time spent commuting is time away from work and personal activities, often leading to reduced productivity and decreased employee satisfaction.
Communication Challenges: With the lack of face-to-face interaction, businesses may face challenges in communication, collaboration, and building a cohesive team culture. Misunderstandings and miscommunication can lead to mistakes, decreased productivity, and potential costs to the business.
Carbon Footprint: The environmental cost of an office cannot be overlooked. Office buildings contribute significantly to energy consumption and greenhouse gas emissions. Even commuting contributes to a company's carbon footprint. Due consideration must be given to green design, active commute facilities, and biophilic spaces to produce sustainable workplaces that employees find worth working from.
In our experience, these alternative costs are rarely given adequate consideration. This is at least partially due to corporate leadership, or lack thereof. The onus, therefore, falls on the leaders to step up, for only they possess the vision and the tenacity to make bold decisions. They are the ones who can navigate the tough calls, the decisions that might dent the budget initially but will eventually churn out a greater ROI.
Real estate spending is expensive, but it’s less a static cost than an investment. To view real estate spending as merely an expense is to undervalue its potential. It should be considered an investment, one capable of returning tangible and intangible dividends to the organization. Look beyond the simplified calculus of which solution costs the least, as this will most certainly cost more. Instead, focus on exploring the ways in which the real estate expenditure can nurture and grow the business.
Pandora's Office
In the end, there was hope. We’ve been thinking lately about the myriad challenges occupiers now face in defining workplace. For many leaders, addressing this topic is akin to opening Pandora’s Box. Indeed, there’s a lot at stake and more ways to get it wrong than right.
The pandemic shone a bright light on 2 facts: 1) technology enables most information workers to work from anywhere and 2) employees have long been yearning for more flexibility in where and when they work. The upshot? Formulating a modern, post-pandemic workplace strategy calls for a different kind of thinking, compelling us to answer new questions. By “workplace” we mean the broad spectrum of options from a fully remote, tech enabled approach to a hybrid model, and extending to the traditional in-office set-up. Whether considered, or not, the outcome of such a workplace has far-reaching implications on a variety of organizational goals, each bearing a different weight in its importance to the company. And some of these goals inherently conflict with each other, making the quest for the optimal solution a complex undertaking.
Never have the decisions about workplace been so challenging. Workplace has always had a broad impact, but there was generally an accepted range of approaches within each sector, providing decision makers with the comfort of conformity (e.g., we’re doing it just as everyone else is). Employees in the financial sector, for example, became accustomed to a specific type of workplace. Today, there is vast difference, even within sectors, as companies adopt their own unique approaches. Understandably, the responsibility for crafting a workplace solution has become a bit of a corporate “hot potato”. Who wants to be responsible for making decisions that will have material impact on productivity, recruiting/retention, company culture, employee well-being, brand perception and overall competitiveness? Don’t all raise your hands at once! The best outcomes necessarily demand input from an executive trifecta: People, Finance and Workplace/Facilities.
Hope. It’s crucial to remember that these challenges also offer opportunities. Opportunities to reassess traditional work models and carve a future that underscores employee well-being, flexibility, and adaptability. The path forward requires calculated risk. Armed with the right mindset and expertise, by asking the right questions, the post-pandemic workplace portends a better future– be it in a space revived with biophilic design, in the flexibility to work remotely, or in a blend of more than one such option.
We’ve moved past the pre-pandemic office. Organizations must embrace the new realities of workplace, engaging the entire company in a thoughtful dialogue about the future. They must possess the right language and they must ask the right questions. Stay tuned (and hopeful) over the coming weeks as we delve into a multi-part series on this topic, dissecting the challenges of defining workplace in the modern context, while providing useful insights and strategies to help you navigate the evolving landscape of work.
The Case for Diversity
Shawn Achor’s excellent book, “Big Potential” references a study by Alison Reynolds and David Lewis detailed in the Harvard Business Review which measured the performance of teams based on “cognitive diversity”, or the spectrum of thinking styles among the team members. It was found that more diverse teams consistently outperform their more homogenous counterparts. Achor notes that, in many cases, despite the benefits of diversity, corporate leaders instead favor like-mindedness among team members. This tendency stems from the misguided belief that diversity breeds discord, hindering the team's overall function. Herein lies a fascinating truth: diversity indeed catalyzes friction, but it's this very friction that fuels better outcomes, sparking innovation and creativity.
Diversification makes everything better, including markets. Over the past several decades, the San Francisco office market transformed into a booming technology hub. Tech companies encompassed an increasingly large share of the demand for space, and landlords preferred their tenancy because they typically moved quickly in making decisions, were often willing to pay higher rents and held the prospect of future growth. However, today the market is paying a steep price for its lack of diversity, as the tech sector has been among the first and broadest adopters of remote work. The market is in turmoil and there is no easy solution. Yet one thing seems clear, the path to future stability must emphasize diversity. A thriving future downtown will most certainly include a blend of housing, schools, green spaces, and a diverse commercial presence.
Diversity also permeates the very nature of how we work. It's important to recognize that there isn't a 'one-size-fits-all' approach to working styles anymore, which is why so many people are gravitating towards remote or hybrid working styles. It enables people to balance their professional obligations with personal responsibilities, bringing work-life balance into reach. By embracing diversity in our work arrangements, we’re not just adapting to changes brought about by contemporary living or technological advancements. We’re also upholding the importance of individual preference and work style diversity – a work environment that truly honors and maximizes our collective potential.
On our TenantSee team, we know firsthand the value of diversity. As we celebrate Asian American and Pacific Islander (AAPI) Heritage Month, we recognize the diversity within our own team and its pivotal role in defining how we think about workplace. If more people understood the positive benefits of diverse perspectives in their workplace, the impetus for seeking such diversity would shift well beyond the empty objective of better optics.
Change is inevitable. Sometimes it creeps slowly, sometimes surging rapidly, but it’s always present. As we navigate rapid changes in how and where we work, as we reassess office markets and search for pathways to reinvent urban core markets, we must intentionally favor diversity for its capacity to make us better, more sustainable. The imperative transcends corporate teams and markets; it is fundamental to the flourishing of our society.
Happy AAPI Heritage Month!
The Price of Innovation
In San Francisco, there’s not much standing between a near-term future in which office vacancies spike to 40% or higher. By not much, we mean demand for office space. What’s interesting is the cause. Many focus on the battle between employer and employee in which employers want the employee back in the office and the employee wants to work remotely. But it’s not that simple. Post-pandemic, employees (especially younger generations) are more inclined to embrace the benefits of technology which enable work to be done from anywhere and make it less compelling, even illogical, to commute to the office. No, this isn’t just about whether you like or don’t like being in an office. It’s about the ways in which tech has advanced to change work and generational differences in the adoption of and comfort with such technologies. Technology changes things. It’s changing the construct of white-collar work, and in the midst of such change there will be winners and losers. The fate of office markets, indeed of the office building as a product, hinges not on resolution of the remote work debate; but, rather, on the pace at which we adopt existing technologies and innovate new ones.
The cycle of technological innovation is unstoppable. It goes against human nature to ignore something which stands to create competitive advantages, and tech is the primary medium through which we create such advantages. Notwithstanding our ability to perceive near-term advantages, we’re not as good at forecasting the potential for longer-range negative societal impacts. Technologies, generally, are designed to replace something with something better, and in many ways, the outcome is often better. In the context of the workplace, voicemail replaced the receptionist, email replaced other forms of written communication, and eventually replaced most phone calls and virtual meetings replaced in-person meetings. Technologies have been eating away at the need for an office for some time now. When adopting technology, first movers gain advantage, enjoy more profit until the rest catch up. Once one company adopts tech and gains advantage, others follow.
I remember how concerned people were by the idea that a customer might call the company and be greeted by voicemail, not a live person. It was just too impersonal. How charming that debate seems today, as we contemplate far more extensive changes in how, where and when we work. Technological innovation has advanced to point in which the next generation of white-collar workers is thinking about work very differently. In the end, this may result in a better future. But we’re now in the messy, disruptive phase, the time when we’re left to figure out what to do with that which has been replaced. As we’re seeing in the debate over generative AI, once a new technology is discovered, it’s difficult to pump the brakes. Corporations race to bolster and protect their competitive position in relation to the tech, and innovators innovate, even as many acknowledge there may be significant downsides. I’m reminded of a quote by Henry Ford, “If I had asked the people what they wanted they would have said faster horses”. Few would argue against the many benefits humans have enjoyed because Mr. Ford didn’t ask the people. Yet for all the benefit, there is a price to pay. As we replace one thing with another, something faster, something better, there is always a price to pay.
AirOffice
Have we reached the point at which the office product might be consumed like the hotel, or the homes and rooms rented on platforms like Airbnb? We’re certainly moving in that direction. Companies like Upflex (a Cushman & Wakefield partner), The Instant Group and others aggregate global facilities for easy access via technology apps. This transition resonates with the growing demand for flexible, location-independent work solutions, allowing employees to effortlessly book an office space wherever required. I’m in Denver, I go to my app, enter my requirements (much like I would do on Airbnb) and, voila! my space is ready. The question is: are we ready to redefine our workspace consumption in line with the on-demand economy?
It’s also interesting to contemplate the implications for space owners (be they landlords or sublandlords). This shift could disrupt the traditional structure of long-term office leases, analogous to how Uber revolutionized car ownership. The idea is radical when you consider the traditional office lease structure. But for coworking or flex spaces, which still make up a relatively small percentage of the overall market, office space is mostly leased to a single company for a long period of time. We’ve long known this arrangement, while serving the investors and lenders (the “landlord”) well, falls considerably short for the occupier because it fails to flex with their ever changing needs. So what would it mean for a space owner to abandon the safety of long-term leases and embrace a more dynamic model? For starters, quite possibly higher income. The primary hurdle lies in the substantial capital required for creating appealing spaces and the need for security in generating and monetizing future cash flow. It would necessitate a shift in the value proposition of office buildings to resemble hotels, considering factors like occupancy rates and pricing. Moreover, current lease structures pose a challenge, with complex sublease and assignment clauses making it hard for tenants to transition their space to an on-demand Airbnb-style model. This cumbersome process stands as a significant barrier to this transformation
While there is clearly market demand for high-flex office products, there are also real impediments to seeing it evolve at scale. But evolve it shall.
Unusual Times
Want to know how strange things have gotten in the San Francisco office market? An empty office building now costs less on a per square foot basis than it will cost to build new interior space in the same building. Cushman & Wakefield’s Project Development Services team has recently released an Office Fit Out Cost Guide (report is here) which indicates the average cost to build new space from shell in San Francisco stands at $222/SF. Now consider that a building like 350 California Street is rumored to be getting buyer interest at around $200/SF.
I’ve never seen a market condition in which the value of the land and building is worth less per square foot than the value of the tenant improvements. What does it mean? Well, for starters, it means the value of empty office buildings in San Francisco is plummeting. Why? Risk and downward trending market fundamentals driven by extraordinary reductions in demand for space. 350 California Street is a good building. It has a nice 15,500 SF, side-core floor plate that is readily usable. It’s an excellent location. It has some decent views on the upper floors. What it doesn’t have is tenants, or at least not many. So as an investment, it’s highly speculative. A buyer is not buying a built-in return generated off existing cash flow. Instead, the buyer is buying into an investment thesis in which it speculates it can spend a certain amount of capital to reposition the building (new lobby, amenities, etc.) and lease it to new tenants at rental economics that will generate a favorable return and create future value.
But why are construction costs so high? In 2 words: union labor. Construction costs have defied gravity throughout the pandemic. You have to appreciate that we were in a very tight labor market for years leading up to 2020. Work was plentiful and the economy was humming. No one blinked at spending over $200/SF to build new space. Now, of course, contractors are beginning to feel the squeeze. Backlogs of work have dried up and pipelines are looking light. True for both general contractors and subcontractors. The challenge is you can’t reduce the value of the union labor contracts. In any case, the high cost to build is not really the reason construction projects are becoming thin. It’s got a lot more to do with the lack of leasing volume, especially leasing in which occupiers are designing and constructing new space.
These are, indeed, unusual times.
Unicorn Farming
Unicorn farming is risky business. I should know. For the past 30 years, I’ve lived and farmed here on the world’s biggest unicorn farm called San Francisco. Growing unicorns requires massive investment. Care must be given almost exclusively to fueling their mythical growth. They’re highly susceptible to infection by ethics, laws, economic reality, truth and any number of other real-world impediments to growth.
Our farm has been successful for many years. Until recently, people came from all over the world to join us. As our population soared, we had to build more structures and hire more farmers. At some point, farming was so good that we stopped selling our unicorns, instead keeping them on the farm to grow astonishingly large, next level mythical. I guess we got a little caught up in our own fairy tale.
Today, our farm is in bad shape. Our unicorns are mostly infected by the scourge of truth and economic reality. No one seems to want to buy a unicorn anymore, especially one of our bloated super unicorns. People are leaving the farm, some voluntarily, others having been forced out. We’re selling off our equipment and buildings at fire sale pricing. Many of the businesses that thrived here to support our farm are also struggling. It’s a hard time.
This old farmer is looking around at the carnage, feeling a bit like the first time I realized Santa isn’t real. I still enjoyed getting gifts, but the magic was gone. Farming unicorns without the magic is, well, just not the same. But I know this much, the magic will come back. It always does. We’re just made to believe. All of us. We want to believe in unicorns, to ride them to the highest heights. Even now, as I write in this dark hour, some of our best farmers are busy grooming a whole new generation of unicorns. Buyers will feign skepticism for a while; but in the end, they’ll come back. They always do.
Solve for Experience!
US office markets are not healthy. The symptoms include reduced demand due to remote work, eroding rental economics due to mounting vacancy and broken capital stacks. The pandemic was the catalyst, but technology is the true source of the suffering. Technology is where many aspects of white-collar work are now done. I asked Chat GPT to define the office and then I asked it to define the office in 1990. Here’s how it responded:
The Office
An office is a physical space where employees of a company or organization perform their work duties. It can range from a small room in a shared co-working space to a large corporate building with multiple floors. An office typically includes workstations or desks, chairs, computers or other equipment necessary for work, and sometimes meeting rooms or conference facilities. It is a central location where employees can collaborate, communicate, and carry out their daily tasks related to the company's objectives. With the rise of remote work, the concept of an office has evolved to include virtual or digital workspaces that allow employees to work from anywhere in the world with an internet connection.
The Office 1990
In 1990, an office would generally be defined as a physical workspace within a building where employees worked to carry out their job duties. It typically consisted of individual workstations or cubicles, shared spaces such as meeting rooms or break rooms, and administrative areas such as reception desks or filing rooms. The office environment in the 1990s was largely characterized by traditional organizational structures, hierarchical management styles, and a focus on efficiency and productivity. Computers were becoming increasingly common in the workplace, but many tasks were still done manually or with typewriters and fax machines. The concept of remote work was not yet widely accepted or practiced, and most employees were expected to work on-site during regular business hours.
What’s noteworthy in the first response is “…the concept of an office has evolved to include virtual or digital workspaces that allow employees to work from anywhere in the world with an internet connection.” In the second response, “Computers were becoming increasingly common in the workplace, but many tasks were still done manually or with typewriters and fax machines.”
Today, many aspects of work can be completed efficiently without going to a designated physical space (office). It seems counter-productive to employees to spend large amounts of time commuting to a physical place to do the things they can do from anywhere, hence this idea that employers must “earn the commute” from their employees. In light of all this, what is the role of the modern office? In a word: experience. Landlords and occupiers must both pivot away from the traditional idea of the office and focus instead on curating the kinds of experiences that make a difference, those which cannot be replicated via tech. What are these experiences? Well, they’ll vary by company, but in general, they will include things like in-person collaboration, in-person mentorship, in-person brand promotion, in-person culture building and other IRL activities. When the modern office is envisioned as an experience center, designed to provide and support the curated experiences that best suit a given company, the friction around RTO goes away. The employer has earned the employee’s commute.
Recently, I had the pleasure of hearing a presentation by leadership at Related Companies. Related Companies has a long development history that includes work in residential, hospitality and office. These days it integrates all 3 to create what it calls “Lifestyle office”. There is perhaps no better example than Hudson Yards in Manhattan. As I have been thinking about the future of office, it’s become increasingly clear to me that this is exactly the type of approach that wins. Hudson Yards is a turbo-charged experience center. Occupiers who choose to lease space there are not analyzing the physical space on the basis of cost/sf. Indeed, Hudson Yards continues to hit new highs when it comes to rental rates. No, the occupiers that choose Hudson Yards have done the heavy lifting to determine what experiences they need to provide their employees and they’ve chosen Hudson Yards because it best supports and promotes those experiences. And you know what, it works. Usage levels at Hudson Yards are substantially higher than in other office projects throughout Manhattan (or the US, for that matter). Employees are happy to be there.
Many employers have begun to express a strong desire to have their employees return to their offices. It’s very important they articulate the why behind this desire. And it can’t be to come and do the same work they’ve been doing remotely for the past 3 years…that’s just not a compelling, or perhaps even logical reason. Companies need to define the exact experiences they seek to provide for their employees and then create an environment that best supports these goals. We firmly believe there is now, and will continue to be, a need for people to connect together, to share common experiences that drive value, both for the employer and the employee. As a community (investor, occupier, advisor, government, etc.), we must begin at once to solve for experience. This is how US office markets begin to heal what ails them. The office will live on in its capacity to produce human IRL experiences. The sooner we abandon the old idea of the office as a place to perform work tasks, the sooner we realize its best future.
Employee, Save Thyself
One of the more fascinating aspects of the conversation around where, when and how white-collar workers work is how it breaks through the guardrails of societal norms. The catalyst for such thinking was the pandemic. People are quick to point out that technologies have been around for decades which enable people to work from anywhere, and that many workers preferred remote work long before the pandemic - - - it’s also true some people preferred not to work even before the pandemic. Yet absent the Black Swan Event that was the pandemic, we simply would not be having this conversation about work. It takes a powerfully disruptive force to cause so much change.
Indeed, the office is but one aspect of the broader discussion around work. It’s sort of the low hanging fruit. Younger generations of workers are ready for substantial change, wanting to redefine offices as voluntary, occasional spaces for specific purposes. They seek freedom from corporate culture pressures, work/life balance, and the ability to work asynchronously. However, proponents of remote work often overlook the broader effects on organizations, the economy, and society. Remote work may result in reduced personal connections, decreased value of employment, and diminished compensation for employees who were previously hired in competitive local labor markets. The normalization of remote work could lead to massive losses in the office market, creating a ripple effect on the economy and potentially causing a systemic shock to the banking system.
Then there’s the impact on cities. Cities might experience substantial declines in tax revenue, rising crime rates, increased street population of drug addicts and mentally ill individuals, small business failures, vacant buildings, and urban decay. While remote work enthusiasts argue that cities should change and diversify, the road to this utopian dream is long, painful, and could take decades to achieve. In the meantime, I would speculate people leave. After all, if there’s no need to be here. You don’t need to be close to an office and your compensation won’t support living in an expensive city like San Francisco. Oh, you won’t want to be here anyway to witness the long state of decline. If you own a home here now, you’ll likely start looking for the exit ahead of steep declines in value. Why did your investment in a San Francisco home appreciate so much over the past decade? The office. Then there’s the societal impacts. I don’t pretend to know how this all plays out. But I do believe there’s value in people interacting with people in real life as the primary mode of communication vs. virtually. Value in being physically together. Value that technology cannot replace, fully facilitate, or replicate. We were meant to be together.
Unfortunately, it’s not easy or natural for most employers to engage their employees in philosophical conversations about work, partly due to management's inability to effectively communicate bigger picture corporate objectives and their connection to workplace strategies at an individual employee level. The balance of power between employers and employees has always favored employers, and this is unlikely to change. As younger generations join corporate boardrooms, large-scale changes are anticipated. However, it is doubtful that domestic or global corporate leaders are prepared to embrace remote work to the extent employees would like. In fact, employers increasingly want employees back in the office. While there is a willingness to explore more flexibility and better work/life balance, employees who resist workplace directives may find themselves left out. Companies have the right to establish their workplace policies, and employees can choose to work for companies that align with their needs. Work is a societal construct. It is an institution that contributes (significantly) to the fabric of society. But it is not a government institution subject to individual votes. For US white collar workers to endeavor to effectuate scaled changes in how we work is mostly quixotic.
When I speak or write about this topic, which is increasingly often, I typically hear from a number of angry people who are strongly committed to the promotion of remote work. As with many topics of discussion these days (most?), opposing points of view must be silenced. At best they’re misinformed, at worst they seek to do harm. People view my LinkedIn post and categorize me as a commercial real estate industry insider advocating for a return to the office to protect my business. However, my true objective is to encourage a more complete consideration of the implications of large-scale changes in how we work. It is essential to think not just about immediate benefits, but also consider how such changes might result in longer-term negative outcomes, adversely affecting individuals and society as a whole.
The Restructure
In markets like San Francisco where availability stands at ~30% and continues to rise, landlords of all stripes have either experienced or are poised to experience gaping holes in their occupancy. At the same time, occupiers having remaining term and paying pre-pandemic rents (meaning rents that are way above current market) are watching the building bleed tenants and seeing the landlord market comparable space at a substantial discount to their in-place cost with massive concessions. This is the perfect environment for restructure transactions.
What’s a restructure transaction and how does it benefit the parties? Restructures come in all shapes and sizes, but they always have 2 defining characteristics:
Create immediate cost savings and benefits for the occupier that would not otherwise be achievable until lease expiration.
Involve a trade of near-term savings for longer-term occupancy.
Occupiers benefit by accessing the soft market early and generating material cost savings. These savings can come in the form of reductions in leased space, reduction in rent, new concessions, or all of the above. And while the near-term savings can be significant, the transaction also allows the occupier to lock in long term value at currently depressed rental economics. The landlord benefit lies in stabilizing the occupancy and avoiding the inevitable bidding war that will result if trying to keep the tenant closer to expiration. Landlords are beginning to see their opportunity to retain existing tenants under normalized circumstances (e.g., when the tenant’s lease is nearing expiration), is limited. In fact, it’s highly advantageous for owners to seek ways of locking in the tenancy well before the tenant otherwise activates a market process. At that point, the degree of options available to the occupier and the extent to which landlords will compete for the tenant make securing a lease extension far more uncertain.
Not all landlords are positioned to participate in this type of transaction. Indeed, it’s best suited to those who are more cash flow oriented and have a favorable cost basis. These are the type of owners that can generate profit from market-based transactions (as opposed to many today who will lose money transacting at market). The exercise of exploring a restructure is pretty straight forward. It begins by assessing the extent to which the existing space meets the current and longer-range objectives. We then run a financial model to evaluate the comparative costs of staying in the existing lease and engaging the market based on the normalized timeline vs. an early restructure. We study the value proposition both from the landlord’s and the tenant’s perspectives. We can then establish a proposal structure to be presented to the landlord. We like to refer to this effort as a “free look” since there is no obligation to do the deal and in exploring its potential, the occupier does not give up any of its future rights. The outcomes range from nothing to a keen understanding of the landlord’s position and motivation - but no deal, to a restructure transaction that makes sense for all parties.
We’ve recently completed several restructure transactions, generating millions of dollars in immediate value for our clients. We’re always available to provide a no cost assessment of your current circumstances. It’s a high value consultation, in any case, as the process necessarily involves a deep dive into the full picture, including current and future market scenarios. Frankly, it’s exactly the type of exercise all occupiers should undertake at this time. We’re uniquely qualified for this type of assignment because of our extensive knowledge of capital and debt markets, our comprehensive research and our broad understanding of the distinct landlord motivation profiles and situational dynamics. If you would like to discuss underwriting a restructure, please reach out to us.
Why Are You Doing That?
We’re excited to promote our upcoming event at Café TenantSee, “Why Are You Doing That?”. For the uninitiated, Café TenantSee is an intimate quarterly in-person event designed to provide highly relevant, useful insights and perspectives for office occupiers. The café opens at 8:45 am on Tuesday, April 25, 2023. Come and order a specialty coffee or tea drink from our expert baristas. Light breakfast is also provided. Our program runs from 9:30 to 10:30. Unfortunately, our café is small. We can only accommodate 50 attendees, so space is limited.
A little about our topic. One of the most vexing issues facing occupiers today is how to formulate the new workplace. Everyone knows the pre-pandemic version of the office no longer serves the more agile, purpose-driven needs most companies are solving for today. Yet there’s many approaches and iterating change can be expensive and risky, given its impact on culture, employee engagement, productivity, brand, recruitment and retention. The stakes are high. Not surprisingly, a recent study by Urban Land Institute and The Instant Group found that many occupiers are still assessing “…activity-based workplaces, flexible working and hybrid”. Indeed, the study finds that only 14% of occupiers have managed to align their offices with their business objectives. We’ve clearly seen this challenge among our client base.
While many struggle to define their version of the future office, we think it’s important to note there are learnings to be shared from companies that have aligned their workplace in service of very specific values and objectives. Our event, “Why Are You Doing That?”, is an opportunity to hear from leaders at 3 such companies, to understand what they’ve done, why they did it and how it’s working. It’s time to move beyond academic discussions of what might happen, to fact-based analysis of how modern workplace solutions are actually changing to better serve the organization.
We’re truly grateful to host 3 amazing leaders from 3 incredible companies, each of whom has chosen a decidedly different path forward. Tracy Hawkins is a leader in the future of work, an expert in remote and hybrid work models. She is the VP Global Head of Workplace Experience and Connection at Grammarly. Grammarly’s approach is Remote-First. Carrie Brandes is VP, People & Talent at Finix. Carrie has a long career focused on people and experiences, giving her unique perspective on the relationships between space and people. Finix is Office-First. Britney Pierini is Global Director, Workplace Experience + Design at Harness.io. Britney also brings deep experience in both people and workplace. Harness.io’s approach is Destination-First.
Attendance is limited, but we’re always eager to know of your potential interest in our programs and content – so reach out if you’re interested. If we can’t fit you in for this one, we’ll keep you top of mind for our next event! We hope to see you there!
P.S., You won’t want to miss the wise sharing from of our special guest panelist, ChatGPT.
A Few Thoughts on the State of San Francisco Office Market
We normally reserve discussion of market fundamentals for our Quarterly market updated, “The Tenant’s Perspective” (which we release just after the close of the quarter). However, as we near the close of Q1 2023, there are several narratives playing out which we deem significant in shaping the near and mid-term market dynamic. We think it’s important to share these now.
By early 2022, demand for office had begun to recover, albeit at considerably lower levels than pre-pandemic. However, by Q3 of 2022, regional demand was once again stalled. Transactions begun in 2021 and 2022 are limping across the finish line, but new demand is muted as companies continue to downsize and/or look to sublease space. The tech sector has experienced significant layoffs and new sublease space has continued to come to market. We are on pace to close Q1 2023 with about 500,000 sf of gross leasing activity, the lowest on record other than Q2 of 2020, when the pandemic froze the market.
Speaking of sublease space, the sublease market is capitulating. Many would be sublessors have been unable to attract a deal for well over 18 months. Available terms are getting shorter, impacting value and sublessors are simply giving up, willing to accept even a modest recovery. Beginning in Q1 2023, sublease rates have begun to drop precipitously. Quality space can now be sublet in the $30s. This is noteworthy for a couple of reasons; 1) most sublessor’s are paying north of $80/sf for their space, so the sublease rents represent a mere 20% to 30% of the existing obligation and 2) sublease values do impact direct space values. When quality sublets that have 3 years or more of term are leasing at such low rents, direct landlords are forced to lower their rents to compete. Expect to see more aggressive downward movement in direct rental rates.
The inevitable outcomes one would expect in a market that is >30% available and which is characterized by decelerating levels of demand are now showing up. Dislocated ownership structures are seeking solutions and there are no easy answers. Equity is lost and, in many cases, debt levels may also be “out of the money”. Special servicers, entities that get involved when owners default on debt and there is not a clear path forward, are increasingly busy. We’ve written recently about non-performing assets, the phenomenon when a building’s capital structure is out of whack with the underlying market such that the building cannot lease space. San Francisco is now seeing a growing number of assets in this category, making the market less transparent and navigable for occupiers.
The San Francisco office market is the most distressed major office market in the US. The market was already a laggard in terms of RTO and was struggling to recover from the profound effects of the pandemic. The impact of macroeconomic events on the tech sector, big and small, has hit the region hard. Occupiers looking to lease space in this environment will have generational opportunities, but achieving such outcomes requires thoughtful strategy informed by a broad base of knowledge inputs, including a full understanding of capital market implications.
What Happens When...
This week we’re exploring what happens when companies define their own bespoke approach to the office vs. when they default to their pre-pandemic office construct, despite significant changes in how they work. To date, many small to mid-size organizations have chosen not to formulate a definitive new approach, instead relying on the old office design and a loosely defined hybrid approach. In a time when the mere discussion of corporate office policy has the potential to trigger highly negative reactions among employees, it takes courage and leadership to advocate a new plan that reflects a vision for the future. Understandably, as we’ve crept out of full pandemic mode and begun to look to the future, many companies have been uneasy about taking a definitive position.
What are the implications of the so called “kick the can down the road” approach? From a physical space perspective, it means a space which is not designed to facilitate new ways of using the office and which is typically too big and low energy. Add to this the preponderance of loosely defined, unenforced hybrid directives, and the result is wasted spend on real estate that is woefully underutilized. While seemingly the “easy” or “safe” choice, this approach actually risks greater damage to the company than when management sets a thoughtful future-oriented course (even if elements of the future-oriented workplace end up being wrong). Why? It signals a lack of leadership or the capacity to think strategically about the office in terms of what it means to the organization - - - the ability to connect the physical office to desired outcomes. In the absence of such connection, it’s difficult for the employee, especially the employee who would strongly prefer not to be in the office, to grasp how it fits into the broader narrative of bettering the company (meaning how it serves the greater good, not just how it impacts the individual). We believe employees, many of whom prefer max flex and agency over their schedule, ultimately respect their employer’s approach when it has been thoughtfully developed and is consistently applied across the organization. What does that look like? It means 3 things:
1) The rationale for the approach has to be truthfully grounded in how it serves the organization, the benefits it brings
2) The message has to be communicated frequently and consistently over a long period of time to reinforce the policy and ensure broad understanding as to why it matters
3) Leadership must demonstrate its commitment to the approach through its actions
It feels riskier for leaders to conceive a new way forward because it requires they ask new questions, starting with why do we have an office? Humans are drawn to routines and patterns, change can be uncomfortable. In the context of corporate decision making, there’s always a fear that a new approach may result in a bad outcome; one, which, in hindsight, will seem obviously flawed and for which the management who promoted the strategy will face personal consequences. But companies are beginning to take definitive action. And as more do, the winners and the losers will become apparent. Talent will be attracted to companies that have a distinct opinion about and approach to the office. This, in turn, will catalyze more organizations to lean into their own version of the future office.
It’s important to point out that in most cases, the extremes are not in play. For example, total abandonment of the office, while happening in select cases, is still a radical idea and will not be the right approach for most companies. Similarly, most companies today are not going to be on the other end of the spectrum, calling everyone back to the office 5 days a week. So the solution lies somewhere in the middle, in a form of hybrid workplace. This is the space in which leaders need to be very prescriptive, intentional. How does the space serve the organization? The good news is there’s only a handful of ways in which the physical office can serve the organization. These include:
Fosters human to human interaction, collaboration and mentorship
Promotes culture
Facilitates connection that leads to healthier relationships
Spurs and supports innovation
Promotes health and wellness
Promotes brand
Causes employees to want to be there
Increases productivity and engagement
While companies can employ surveys and other means to take the pulse of the employee, we’re not convinced this is the best approach. Firstly, it fails when companies survey their employees and ignore the results. And let’s be clear, employees often lack perspective for the bigger picture. They’re more focused on how the office impacts their daily lives than on how it impacts the enterprise. This is why it’s so important for leaders to take a stand on this subject, to define and enforce the organization’s office policy. Not because it serves some draconian view of management oversight, but because of how it contributes to the overall health and prosperity of the company. By the way, if the solution does not positively contribute in this way, don’t do it. Pre-pandemic, leadership could get away with glaring inconsistencies in how they conceived the office, who had to be there and who didn’t. The majority of the employees could be forced to be in office 5 days a week, while senior leaders had the kind of freedom most employees now enjoy (post-pandemic). That inconsistency did not go unnoticed. The difference is, these days, employees have had a taste of freedom and they will revolt against office policies that are not clearly grounded in the truthful pursuit of making the company better.
What the office is decidedly not about (any more) is a singular place where employees are forced to go to do work. Work can and does happen in a variety of places. In most cases, the modern office is about providing a place for essential human interaction, the kind that simply cannot be replicated through technology. We’re excited to bear witness to and to help facilitate a shift toward the discovery of what happens when companies get really thoughtful about office and take definitive steps to iterate new approaches. It’s here that we (finally) begin to move forward, to acknowledge that much has changed and to harness the value that will come from new ways of engaging employees through the built environment.
It's Tricky
Despite being awash in available space, the San Francisco office market can be tricky to navigate. By now, everyone knows the market is distressed. When companies explore leasing options, they do so with the expectation they will be able to trade up for better quality space at substantially reduced pricing; or, they expect to significantly decrease the cost of their existing space with a lease extension. These are reasonable expectations, yet they can be elusive for several reasons.
Firstly, there is the issue of scarcity in the premium space market segment. Over the past couple of years, when tenants have chosen to relocate in San Francisco, it has often been to premium view space. Landlords, experiencing steep declines in the value of commodity space, have made a last stand, holding firm or increasing rents for the best space in the building. And occupiers have shown a willingness to pay. There are few bargains in the premium space market.
Another surprising and unanticipated factor is the cost of building new space. While rental economics have fallen, construction costs have continued to rise (don’t ask me how this makes sense, I can’t tell you). These days, when tenants choose to relocate, they’re mostly focused on creating custom designed space that better solves for return to office. But it’s very expensive to build new space and landlord allowances typically cover about one-half the cost, leaving the occupier with a very large cap ex to manage, often making the transaction non-viable.
Then there’s the non-performing asset issue. We’ve expanded on this previously, but the short version is some landlords and their lenders are simply not in a position to make deals right now. The capital structure of the asset needs to change and has yet to do so. These non-performing assets can be tricky to identify, as absent good advisory, you only know when you know. This same issue can impact the values a tenant might achieve in a lease renewal where the landlord is simply unable to meet the market.
All these variables combined make for a more challenging market than would otherwise be expected given the circumstance. The one place where occupiers are near certain to see value commensurate to the distress in the market is in the commodity space segment. When a company is willing to lease space in the lower half of the building, where the view is typically obstructed and the light constrained, landlords not struggling with capital stack issues will offer great value to secure the deal. Yet as noted earlier, most tenants who are otherwise looking to relocate have a strong interest in upgraded space options… they’re not really focused on the commodity supply. It can be tricky out there. Our simple advice? Retain a qualified, experienced advisor from a firm that is sufficiently resourced to understand the full landscape (capital markets, etc.), give yourself plenty of time and be sure to look carefully at not just the asset, but also the capital stack to avoid non-performing assets.
IRL vs. URL
Lately, something has been bothering me (IRL). I’m losing sleep. I don’t understand how life can be IRL and URL. To me, life is only IRL – there is no such thing as URL. Technology is merely a construct that we created, presumably to make IRL better. What began slowly, now rapidly causes big shifts in how we experience life, IRL. Not all change is good. The modern office is among the high value social constructs which technology seeks to upend. The office IRL is fast becoming the office URL. Is this a good thing?
The idea of separating life into IRL and URL is fundamentally harmful to society. Twitter is an excellent example. There, people interact with others very differently than they would if such interaction was in person. We have 5 senses; sight, taste, touch, smell and hearing. We’re designed to use all 5 to engage our environment. Yet in the digital realm (URL), we can’t engage all our senses. In addition, we don’t share a common experience, anchored in place. I’m not suggesting that taste, touch and smell are particularly useful in most business meetings (at least not the ones I’ve attended). But I do believe there is something uniquely important about having all senses activated in the same context, about how this translates to a shared human experience. Maybe this is among the reasons Zoom calls suck, because we can’t fully appreciate the environment in which the communication occurs. A number of our senses are disabled and/or we’re having an individual sensory experience which is disconnected from that of the other participants (e.g., I’m hearing my infant child cry in the background, or I’m hungry and my partner is cooking in the kitchen).
I think people are being sold a bill of goods when it comes to the office URL. For example, they see the immediate ways in which abandoning the office feels good, how it provides more work/life balance, eliminates their commute and possibly allows them to relocate from an expensive region. But they’re failing to fully consider where this is heading. More URL, less human connectivity. The big winners will be those who build the infrastructure to support URL. A massive market. This is why Meta has already spent $100 billion dollars and will spend many billions more to create the metaverse. Yet just as 1985 you (assuming you were born then) likely lacked the foresight to predict that 2020 you would buy everything from groceries to a new car from the comfort of your couch; it’s hard for us to wrap our minds around a future in which we visit the office in the metaverse, or we shop at the mall in the metaverse. But at the current pace and nature of technological advancements, this is the future.
One day your company will announce a remote-first approach to the workplace. Next you’ll notice that geographic proximity to an office is no longer important, maybe not even possible. The only role geography will play in the labor markets is in terms of how it limits the employee, not the employer. The employer gains profit by lowering its cost of labor through talent acquisition on a global scale. Those who live in expensive geographies will find it harder to compete for work because their cost of living is not supported by their compensation. Cities like San Francisco and other highly desirable geographic regions will increasingly become socio-economically homogenous (already started). Labor costs will be steadily pulled downward by the availability of qualified talent living in the least costly regions of the world. We’re in one of those moments where the employee is “winning the battle but losing the war”. So strap on the virtual reality headset, call the movers and get agile. Oh, we should also talk about your new colleague, AI. Some of your colleagues will be bots (maybe already are). Of course, it will be difficult to compete with a super computer, the contributions from which are informed by the scraping of zettabytes of data. And AI doesn’t ask for a raise, it doesn’t take vacation and it’s rarely sick.
I hope we can take a moment to think more holistically about the promise of the office URL. Technology is real; but increasingly, the experiences it facilitates are not (or are less so). Before we fully destroy the modern office and the cities in which it was built, it’s worth spending a moment to consider that while the modern office has its limitations, it remains human-centric. It fosters human connections and engagement IRL. Maybe that matters.
Unpleasant to Existential
When the pandemic hit in 2020, emptying San Francisco office buildings, landlords were mostly unfazed given high levels of occupancy and income. As the pandemic gained momentum, some owners began to quietly wonder if this could be bad enough to render their buildings empty for a prolonged period. Yet it wasn’t until late 2021/early 2022 that investors began to fully grasp that appetite for their product had changed in significant ways.
The underlying economic fundamentals of the office market are, of course, a product of the supply/demand dynamic. For decades, San Francisco office investors enjoyed a market characterized by surging demand and limited supply, resulting in ever-more favorable leasing fundamentals. Occupiers were forced to navigate a market that at times bordered on ridiculous. While the pandemic initially caused many landlords to brace for a difficult period in which some “unpleasant” deal making would be necessary to ride through the cycle; now, some 3 years on from the first utterances of COVID-19, the situation has shifted from unpleasant to existential.
Office buildings are an expensive investment. They cost a lot to build, to buy and to run. They require ongoing investment to ensure successful leasing. To generate better returns, they’re usually financed with debt. These days most large office assets are owned in a financially engineered partnership consisting of equity and debt. These partnerships are designed to maximize returns. Like any investment, they’re a bet on the future. The investment is mostly conceived to generate profit. Less attention is given to preserving the investment if the bet goes wrong. Investors can weather some amount of downturn, but there is a point at which the structure breaks down. Many San Francisco landlords are there now. This is not as much the result of bad bets, as it is a “black swan” event. The current state of the market was not reasonably predictable.
But here we are. It’s important for occupiers to understand what is happening as we enter a period of significant dislocation. In simple terms, think of the San Francisco office market as having an underlying cost basis in the range of $800/SF, a value that requires rents of about $80/SF across about 85% of the asset to generate adequate NOI to maintain valuation. So those would be the basic characteristics of an investment that was performing adequately well. Yet with demand off by as much as 50%, supply steadily increasing and now standing at about 30% available and rents on the decline, now standing in the low $70s for all but the most premium view spaces, the $800/SF investment structure is untenable. It must either be broken in favor of a totally new investment (one with a much lower cost basis), or the original parties must elect to invest more in the asset and incur even greater losses to hopefully ride through the cycle to a future in which the asset can regain its lost value. This latter scenario is unlikely given the severity of the downturn and the lack of visibility into future of office occupancy.
It takes time for a dislocated market to find its equilibrium. During this phase, occupiers must be aware of which assets are “broken”. Make no mistake, we’re now in the existential phase and while the losses are on the landlord side of the table, the impact can have negative repercussions on occupiers, as well.
Maybe The Office Isn't So Bad After All
There’s been a lot written over the past 3 years about the negative aspects of office life, about how it harms our health, distracts us from what really matters and makes us less productive. The freedom to choose where and when we work, it’s argued, is transformative, enabling us all to create our own perfectly tuned work-life balance. It sounds nice, the idea that no one (at least no white collar worker) will remain oppressed by the constraints of working at an office, or working on a fixed schedule. Turbo-charged gig workers, calling our own shots. What could go wrong? Maybe a lot.
For starters, we earn less. Labor costs go down when the labor pool is global vs. local. Don’t buy it? Look at what happened to manufacturing costs when supply chain went global. Made in America doesn’t win when made in China costs 75% less. Secondly, the connection between nomadic mercenaries and their employers is not strong. It’s not personal. I compare this erosion in connectivity to what happened in dating with the advent of dating apps. Suddenly there’s always a new, more exciting option just a swipe away. No need to get too invested in the current state.
But employees are more productive when working where and when they want, you say. Let’s unpack this a bit. I’ve worked in the commercial real estate sector my entire career – this is my bias. Brokerage is a business which lacks structure; or, more positively, it provides a lot of freedom. Freedom to choose when and where you work, for example. Yet many would be commercial real estate brokers fail because they lack the discipline necessary to thrive when no one is looking. I’m not saying we’re inherently lazy. I am saying we should look at how we behave when we have more control over our time and we don’t have to work in the presence of others. In this context, brokerage is a great proxy. Especially when you consider that brokers who work harder and smarter, but always harder, earn more money. There’s a 100% correlation between effort and return. So even here, when the broker should be sufficiently motivated to do more, it’s often the case they fail by doing less. But what of the salaried employee? Would it not be in keeping with the capitalist instinct to find a way to positively leverage a newfound opportunity to shift the work-life balance dynamic a little more in favor of life? After all, if my role does not permit me to enjoy a material increase in compensation by working more (and most don’t), my leverage lies in maintaining the same compensation while working less. I’m not one of these draconian types that believes everyone must be relentlessly monitored. I’m just a realist when it comes to human behavior and the economic motivations created in a capitalist economy.
Passionate rejection of the office flirts (dangerously?) with what could be described as economic anarchy. Society has structure because humans need structure. I don’t love all aspects of my work life. Some days I don’t want to go to my office. Some days, I want to do whatever I want to do. My business allows me the freedom of choice. But when I choose to do something other than work, I do so knowing my choice comes with the possibility of less earnings. This is an economic reality.
We’re in a moment in time when we should be asking the harder questions. Instead, I’m mostly hearing a tired dialogue characterized by surface level arguments for and against the office, as if it’s a binary choice, not something that has deep societal implications and knock on effects that go way beyond the obvious. It is entirely possible the office creates more value than we realize, both for society and for individuals. If we make sweeping changes in how and where we work, we may inadvertently destroy vital aspects of our society, creating long term negative consequences. It’s worth considering the benefits (societal, individual, corporate) of the modern office. Maybe, just maybe, the office isn’t so bad after all.