Flexibility Can Be Expensive

These days, many companies place a premium on flexible leasing. This is understandable in a time marked by uncertainty about the office. It is also a byproduct of a shifting market in which landlords have increased the extent to which they offer flexible solutions. Less obvious is how flexible leasing can end up costing significantly more than longer-term leasing.

A flexible lease is usually under three years in term. It is almost always a pre-built space, often furnished and ready for occupancy. Flexible leases come in the form of both direct and sublease offerings. Subleases may be discounted to market because, absent protections such as a recognition agreement from the landlord, they present a risk of losing the space if the sublandlord defaults. Yet high-quality subleases that align with the type of flexible offerings otherwise being provided by landlords are usually priced similarly. These spaces are not discounted and are often priced at a premium to the longer-term market.

In other words, flexibility costs more. This is true in part because landlords must rationalize the expense of building new space over a shorter term, and it is more difficult for them to create a positive impact on asset valuation with short-term leases. As a result, flexible leases carry a higher cost.

There is also an element of market risk, especially when the rent trajectory is rising. For example, rents in San Francisco appear to have hit bottom and are beginning to trend upward. A tenant that signs a three-year lease today is likely to face higher leasing costs in roughly two years when addressing the expiration, whereas it could have locked in a historically lower cost for a longer period. As markets improve, leasing options also diminish, making it harder for tenants to find high-quality space. Finally, as leverage begins to shift back toward landlords, concessions are often reduced quickly.

To be sure, choosing a flexible lease may be the right answer, regardless of the longer-range cost implications. But it is important for tenants to recognize that flexibility can be expensive.