Resizing or Right-Sizing?
Prepare for the smaller (and smarter) corporate office.
By Rich Rosfelder |
around the globe have been holding on to office space in anticipation of a
market rebound, but that’s
about to change. “A
growing number of corporate property owners say they have up to 50 percent
excess leased office space,” according to Jim Young, CEO of RealComm, a
commercial real estate and technology advisory firm. “Their goal over the next
five to seven years is to eliminate that excess space.”
That “50 percent” figure might be shocking,
until you reflect on recent changes affecting corporate office space usage. In
the first 10 months of 2011, employers announced more than 520,000 planned job
cuts, according to outplacement company Challenger, Gray & Christmas. While
well below recession levels, this figure marks an increase of 16 percent over
the same period in 2010.
At the same time,
technology continues to reshape corporate office culture. Those who keep their
jobs are now more likely to work outside the office, at home, or at client
sites. According to Teknion’s recent Workplace of the Future study, 46 percent
of companies surveyed currently employ cloud computing — which allows employees
to access company data from any computer — and 90 percent plan to increase
their investment in productivity-enhancing technology by 2015.
Thus, when it comes to
corporate office space usage, bigger is no longer better. At November 2011’s CoreNet Global Summit in
Atlanta, Peter Miscovich, managing director of corporate solutions for Jones
Lang LaSalle, predicted that by 2015, the average square footage allocated per
employee will shrink by up to 75 percent, depending on the industry sector.
The new paradigm is “smaller and smarter,” Young says. But less space
means smaller and possibly fewer leases. If portfolio managers and brokers hope
to compete in the changing corporate real estate landscape, they need to
understand how companies are preparing for tomorrow’s office.
What does tomorrow’s office look like?
According to Johnson Controls’ recent study Collaboration 2020, during the next
decade employees expect to spend less time at their desks and more time working
in dedicated collaboration rooms and communicating via video conferencing.
Many companies have
already begun to implement what is perhaps the most striking innovation: shared
seating. Some prefer a reservation-less hot-desking arrangement, while others
use hoteling, which requires employees to reserve unassigned seats. Either way,
idea of an office where you can hang pictures of your family and display your
sports trophies is a thing of the past,” Young says.
This change seems to be a
natural outgrowth of the increased popularity of mobile technology. According
to an international workplace study by Cisco, three out of five workers say
they don’t need
to be in the office to be productive anymore. With a laptop, tablet,
smartphone, or some combination of those devices, many office employees can
work anywhere they can get online.
This also means that time
spent in the office is often dedicated to meetings and other face-to-face
activities rather than sitting at a desk. According to the Workplace of the
Future survey, 77 percent of corporations are already utilizing more open,
collaborative workspaces and fewer individual offices.
Ryan M. Lorey, CCIM,
director of global real estate at Booz Allen Hamilton in McLean, Va., recently
coordinated his company’s
move from two buildings totaling approximately 750,000 square feet of old,
inefficient office space in Tysons Corner, Va., to newly designed buildings
with shared seating. “Our
15-year lease terms were coming up, and the buildings’ heating, ventilation, and
air conditioning and other infrastructure were reaching the end of their
functional economic life,” Lorey says. “All of the new buildings were designed for maximum
efficiency, with more collaboration space and a hoteling environment, so
eligible employees can work where they need to, when they need to.”
Technology is also helping
corporations redefine their office space utilization. “We are implementing
alternative work environments in every new project,” says Dennis Virzi, CCIM, a
senior portfolio manager with AT&T in Dallas. “By deploying high-speed
Wi-Fi and Follow Me telephone services, we can offer a functional workplace at
approximately half the footprint of a traditional cube layout.” Virzi’s company is currently in
the process of eliminating an expensive lease. Using only technology
enhancements, they plan to accommodate 150 employees at a new location that has
only 85 workstations.
Other corporations are
finding shared-seating opportunities and collaboration space in their current
portfolios. Liam Murphy, CCIM, of Hayes Commercial Group in Santa Barbara,
Calif., recently worked with a client who began using offices previously
reserved for traveling executives to accommodate hot-desking. “Now they are able to fit
more of their regular staff into the corporate office without taking on more
Murphy explains. When the economy bounces back, corporations that recognize
these opportunities will be able to expand without leasing additional space.
At What Cost?
But as full economic
recovery continues to recede into the distance, most corporations are still
focused on cutting costs rather than expanding payrolls. The key to reducing
costs associated with a leased office portfolio is also one of the keys to
creating a smaller and smarter office: Study occupancy needs. A careful
analysis is almost certain to reveal excess space that can be shed or used more
are the days when brokers and real estate directors can use generic formulas to
calculate occupancy needs,” says Andrew Harnish, CCIM, director of enterprise
development for Johnson Controls in Seattle. “In today’s global, virtual, and dynamic workplace, we need
to analyze how people work together, where they work together, when they work,
and the frequency of their desk and conference room usage.” This process might involve
interviews, direct observation, or the installation of temporary motion sensors
that track space usage. “Though
this seems like an expensive study, the cost is very little compared with the
inefficient space being paid for over the life of a lease,” Harnish adds.
A shared-seating setup can
also give companies more information about their workforce and how they utilize
office space. At Booz Allen Hamilton, employees must reserve a space, with a
five-day max per reservation. To get metrics, Lorey collects data from the
online reservation system. Though the results are still preliminary, he expects
the company will reach 80 percent utilization after all of the renovations are
Johnson Controls recently
worked with a global company that transitioned to a shared-seating arrangement
for several reasons, including cost. The company reduced its carbon footprint
by nearly 20 percent, resulting in an annual savings of more than $3 million.
Another client that made this transition was able to reduce infrastructure
needs by 15 percent, Harnish says.
is always more efficient to consolidate,” says Stuart L. Rosenberg, CCIM, SIOR, president of
ICI Commercial in Arlington Heights, Ill. “Typically, utility costs can be cut just by
reducing the amount of exterior wall space exposed to the elements.”
Corporations that aren’t ready to consolidate
should consider taking advantage of today’s rent rates to prepare for tomorrow’s office. “Open a dialog with the
landlord for a blend and extend,” Virzi says. “Market rent rates are down and most owners are eager
to extend lease terms. B&Es are also a good way to obtain fresh tenant
improvement funds, which takes the pressure off corporations’ operating budgets for
things like new carpeting, paint, and landscaping.”
incorporating early termination or “buyout” language into every new lease, as it saved one of
his clients hundreds of thousands of dollars. For example, a seven-year lease
might have a termination option after the third year. “The end result is that
corporate users do not have to absorb the risk of subleasing if their demand
for space changes suddenly,” he explains. “Most of our buyout clauses end up being a penalty
of 10 percent of the remaining lease liability, which ensures that the landlord
is compensated for unamortized TIs and brokerage commissions.” Tenants have the option to
terminate, and landlords get an extra check.
Other consolidation and
expense-reducing opportunities are out there, but small companies may not have
the resources to discover them. In that case, Murphy says, “Copy the big guys.” Most Fortune 1,000
companies hire consultants or create full-time positions to identify and
implement these strategies, and small companies can borrow and apply the
strategies that work for them. For example, as a branding tool, companies such
as Cisco and Intel release white papers that outline their sustainability
efforts. Other companies publish their criteria for landlord vendors, which
might include a list of specific tenant improvements. “Best practices are best
Murphy adds, “no
matter who discovers them.”
Rich Rosfelder is associate editor of Commercial
Investment Real Estate.
Changing the Corporate
Proposed FASB rules could
have unintended consequences.
The single most important
change of the proposed Financial Accounting Standards Board lease accounting
standards would be eliminating the distinction between capital and operating
leases. Under the proposed guidelines, companies would be required to recognize
every leasehold obligation (in excess of one year) on its balance sheet.
But will that change the
way corporations make their real estate decisions?
As part of our graduate
thesis project at the Massachusetts Institute of Technology Center for Real
Estate, we interviewed representatives from 29 companies to answer that question.
We conducted targeted interviews with a diverse sample of companies
representing tenants, landlords, and other industry professionals, from both
the public and private sectors.
We concluded that the
proposed changes in lease accounting would not cause an industry-wide shift in
corporate real estate strategy. However, for those companies that value the
accounting impact of real estate decisions to a greater degree, the proposed
changes could be a catalyst for changes in real estate behavior.
The impact for a
particular firm would be largely based on two main factors: the size of a
operating lease portfolio relative to its balance sheet and a company’s sensitivity to financial
statement presentation. These factors
make a company more likely to change its behavior to mitigate the effects of
the proposed changes.
We also discovered through
our research that the proposed accounting changes would require companies to
incorporate sophisticated lease tracking systems in order to comply with the new
reporting requirements. For example,
since a balance sheet entry for a particular lease could change over the lease
term based on the likelihood of certain events (such as the exercise of a
termination or renewal option), more analysis and more communication between
internal departments would be required. For instance, corporate real estate
groups would need to discuss transactions with corporate finance and accounting
groups. As a result, companies would
scrutinize their real estate footprint in greater detail and have a greater
awareness of any inefficiency in the space they occupy. Companies would be
better equipped to make real estate decisions that would lead to increased
efficiency in the market.
Timothy Canon was a senior analyst for
Boston-based real estate advisory firm Richards Barry Joyce & Partners, and
Christina Fenbert is a portfolio analyst for Colony Realty Partners in Boston.
responses were based on the tentatively agreed upon FASB/IASB changes as of
July 2011. Read the complete research synopsis.