The True Value of Agile HQ

by Eugene Lee: May 16, 2018

By Eugene Lee

Global Head of Real Estate & Business Development

In today’s dynamic market, companies face increased uncertainty. Whether they are a fast-growing startup or an established corporation, senior management typically has a high degree of confidence in what the business will look like for the next few years. But the future beyond that is hard, if not impossible, to predict.

Despite this reality, companies can’t choose—or in many cases even influence—the terms on which they acquire office space. The traditional lease forces would-be tenants to sign long-term deals that extend far beyond their plans, without accounting for their actual needs.

That’s partially because of the way most executives have traditionally thought about real estate.

“Business real estate is not merely an operating necessity; it’s a strategic resource,” writes Mahlon Apgar in the Harvard Business Review. “But it rarely captures senior management’s attention. In many organizations, real estate remains a reactive, second-order staff function, focused on discrete projects and deals rather than on the company’s broader strategic issues.”

For example, let’s say a company knows how much space they need for the next three years and decides to sign a 10-year lease. In all likelihood, the company will need a new space after three years—one that’s either bigger or smaller.

Unfortunately, it’s not as simple as packing up and moving. When the company tries to get rid of its current space, a number of painful and costly things happen—none of which are factored into traditional lease costs:

Direct Expenses

1) They have to hire and PAY a broker. If the broker finds a company to sublet the space, the company pays that broker a commission (e.g., 6%). That commission is an upfront, out-of-pocket expense for the company.

 

2) They PAY double rent. It’ll likely take even the best broker three to six months to find a new tenant. If the company finds a new space before then, they’ll be paying rent on the new and old space.

 

3) They PAY legal fees. Once the broker finds a new tenant, the company will need to negotiate a sublet and pay legal fees.

 

4) They PAY for tenant improvements. Maybe the new tenant won’t have a use for the fancy conference room and would prefer it to be a kitchen or pantry. The company will have to pay for some tenant improvements to close the deal.

Hidden Costs

 

5) They have to find a subtenant. Maybe they get lucky and a friend agrees to sublet the office. But they need to get lucky. Otherwise, see item #1 above.  That subtenant also needs to be approved by the owner, and that’s an unpredictable process.

 

6) They give the subtenant a few months of free rent. It is standard practice to give free rent to incentivize a subtenant, so this extends any double rent period.

 

7) They won’t cover their own rent because they’ll give a discount to the new tenant. Sublets are often at a discount to the original lease, in some markets by almost 20%.  Let’s say the company has been paying $45/sf. The subletter might offer $38/sf. Now, instead of losing $45/sf, they’re only losing $7/sf. But that’s still money that can’t be invested in growing the business.

These direct and indirect costs are huge—and most companies don’t account for them at all.

But it doesn’t have to be that way. Many forward-thinking organizations are turning their backs on long-term leases and increasingly looking for offices that give them flexibility. This is part of the reason why 13.4% of U.S. commercial space sat vacant in Q4 2017, according to data from Cushman & Wakefield. It’s also why occupancy growth continued to slow in Q1 2018, as JLL’s research reveals.

“The nimble organization ensures that it has maximum flexibility throughout its real estate holdings—even if that means paying more up front in some instances,” Apgar continues. “Shorter terms, with more frequent and earlier termination dates, expansion and exit clauses, and renewal options, can help a company adapt to changing circumstances.”

This flexibility ultimately saves organizations a lot of money.

To date, no one has done the work to quantify how just how much savings companies with nimble real estate strategies can expect—until now. What follows is the first authoritative study on flexibility in the New York City commercial real estate market.

Quantifying Agile HQs in NYC with Real CRE Data

Imagine you sign a 10-year lease for 10,000 square feet in a Class B building in Chelsea—despite the fact you only plan on staying there three years.

Odds are you’ll end up paying a 23% premium on that space when all is said and done.

A $70/sf lease, for example, actually ends up costing $86.44/sf after accounting for the costs associated with subleasing and finding a new space: broker’s commissions, free rent, discounts, tenant improvements, double rent, and more.

All of a sudden, an office you thought would cost $58,333/month balloons to $72,036/month. Your runway shrinks.

This example illustrates the real expense of buying something that wasn’t a good fit.

Smart organizations understand this reality, which is why they’re increasingly outsourcing real estate procurement and management whenever they can.

“The most efficient organizations often do the least to operate their business real estate,” Apgar writes. “Instead, they team with firms offering the full range of facilities functions and services.”

Don’t be fooled. A lease is not just the rent—it has tremendous implications down the line. Break your lease in three years and suddenly you face other significant expenses. Some might be indirect, but several require you to write a check.

Crunch the numbers before you sign a long-term lease. The last thing you want is to end up contractually obligated to pay a lot more money than you anticipated, for a long period of time, for space you end up not needing.