Resizing or Right-Sizing?

Corporations 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.

Sharing Space
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, “the 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 square footage,” 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 efficiently.

“Gone 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 complete.

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.

“It 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.”

Murphy suggests 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 practices,” Murphy adds, “no matter who discovers them.”

Rich Rosfelder is associate editor of Commercial Investment Real Estate.

Changing the Corporate Culture
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 company’s 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.