As the economy continues to struggle, decision-makers are taking a different approach when evaluating corporate relocations and office expansion strategies. During the dot.com era, many companies were dreaming of hitting the proverbial pot of gold at the end of the rainbow. CEOs became visionaries, choosing office facilities with plenty of room for hiring sprees and expansions that never materialized. Now firmly in the grasp of an anemic economy, corporate real estate decision-makers are analyzing their choices to ensure they don't make the same mistake twice. A conservative approach is dictating the choices being made when considering corporate expansion or relocation.
A Short-Term Approach
One of the most obvious signs that perceptions have changed relates to shorter-term lease agreements. For many businesses, the emphasis has shifted to being nimble and avoiding long-term commitments. Ten years ago, companies were signing lease agreements for five to 10 years; now, that's dropped to three- to seven-year commitments on average, since tenants are being advised to maintain operational flexibility. While most corporations would like to consider their business strong enough to weather the current recession, long-term agreements simply aren't desirable with so many unknowns. Unlike before, corporate real estate executives, CEOs, and CFOs are proceeding cautiously and recommending a wait-and-see approach to determine if growth forecasts align with reality and justify expansion.
In most markets, rates are likely to hold steady in the near future, making this shorter-term approach more palatable. Even in this period of economic uncertainty, companies weighing a move to a new location can still make that progression provided their real estate advisor is successful in negotiating favorable terms with a new landlord regarding rent, lease term, relocation and construction allowances, plus options to expand for organizations anticipating increased growth as the economy improves.
However, while shorter-term leases and reduction of large-scale corporate relocations may be advisable from the operational side of the equation, this creates challenging market conditions for commercial real estate firms that rely upon these businesses to generate activity. Until business confidence returns and the nation's employers once again spur job creation, the commercial real estate market may remain a shadow of what it was in the boom of the early 2000s.
Winners and Losers in the Plug-and-Play Search
With new construction projects steadily decreasing over the past five years, existing inventory consists of many older structures lacking modern amenities and the environmental improvements introduced by newer LEED®-certified facilities. This is another factor that is leaving companies with fewer options when searching for new space. Diminished job creation and limited project financing has reduced demand for new speculative building projects, effectively slowing construction starts and leading to a supply of obsolete buildings. In turn, the argument for relocating to upgrade to a better space becomes less of a driver.
This can lead to a ripple effect, as start-ups considering leasing their first office are likely opting for plug-and-play space that contains furniture and phone lines. These properties are more desirable than unfinished offices, as they eliminate some of the costs associated with a move. For example, often overlooked or underestimated move costs can include technology purchases, furniture purchases and installation, the procurement and integration of audiovisual and security equipment, and finally any lease-related disposition costs associated with the move from a tenant's previous location.
For start-ups, a plug-and-play facility makes financial sense. However, as long as the companies currently occupying those properties continue to maintain a wait-and-see approach, economical property choices for young companies remain scarce. Most of the current supply consists of unfinished units that require additional outlays to become fully operational, or outdated facilities requiring similar investments for modernization purposes. If there are any winners in this economy, it is smaller organizations that are past the initial start-up phase, have stabilized their funding, and are beginning to grow. These types of organizations are exploring their options for expansion, while maintaining the flexibility to remain in their current location. Those businesses that are stable and can also grow within their existing space may find themselves in the best position of all by leveraging market conditions with their landlord to secure a lower rate for a short-term contract, thus avoiding an expensive relocation.
Other opportunities exist for those businesses that need to remodel workspaces or move to a larger facility in order to complete new projects or accommodate larger workloads. With a healthy supply of unfinished facilities to choose from, these organizations can either barter for a more generous tenant-improvement allowance in their current facility or search for a more competitive deal in another location.
Has the Bottom Fallen Out Yet?
For many industry experts, the recession of 2011 is a much different animal than the downturn of the early `90s. By the middle of that decade, the economy had begun to recover and show signs of life despite the calamitous collapse of the housing market. Today, the effects of the recession are much more entrenched and less likely to correct themselves despite the best efforts of the Federal Reserve.
In the short term, small to mid-sized companies with strong potential for growth will continue to be the primary drivers of commercial real estate activity, albeit with shorter-term commitments. For tenants with contracts ending in the near future, there is little harm in negotiating for an extension and taking advantage of current market conditions to obtain more desirable terms or renovation allowances. Tenants should also feel comfortable exploring what options exist if relocation is necessary to support their business, while remembering to maintain operational flexibility.
A broker can help guide a company through the pros and cons of shorter- and longer-term lease extensions, depending on what the goals of the business are and its prospects for the future. However, clients also need to understand the nature of their own business and how it relates to their corporate real estate decisions.