Down Market Presents Surprising Opportunities for Commercial Deals
David Mandell April 25, 2016, 9:08 a.m.
It’s no secret we’re on the cusp of an economic downturn. Analysts are predicting that we are heading toward a recession with potential to outweigh the crash of 2008 and our commercial clients are bracing themselves for the shift in ways we can fully expect to impact commercial real estate sales.
While the specifics of the crash are still riddled with uncertainties, we’re at a stage where the commercial real estate community has to make a choice: fall victim to the state of the market as we have in years past, or start planning for a down market and adopt unique strategies that will drive commercial sales regardless of the state of the economy.
We’ve been through this before.
In 2001 the sputtering economy drove commercial clients to cut budgets and scale back on space. As a result, 20 million square feet in sublease space flooded NYC. The 2008 crash marked the moment in time that took the trend of leverage out of fashion, and instead, drove clients to begin stockpiling cash reserves. Smart businesses committed these experiences to memory and today are executing more conservative practices across the board to prepare for the chance that they see a similar fate in the future.
San Francisco is showing early symptoms
Although VC cash in San Francisco shielded SF businesses from the impact of 2001 and 2008, today the city is experiencing a market shift in advance of the rest of the nation. As VC money scales back in San Francisco, commercial clients are making tough decisions early to employ more sustainable growth rates — cutting headcount and office expansions to streamline burn. As a result, we’re looking at the same spike in sublease activity in San Francisco that we saw in NYC in 2001. At 1.9 million square feet, sublease space in San Francisco today is at its highest level since 2010, reported Bloomberg. That’s a 46% jump from the end of third-quarter 2015.
Optimizely, a very well-funded and revenue-driven organization, recently chose to cut 10% of employees to plan for the potential that a shifting market could result in lower sales and missed targets. Optimizely co-founder/CEO Dan Siroker writes of his decision to execute layoffs in a piece called “Controlling our own destiny.”
Wake-up call: Business are controlling their own destiny
It seems that San Francisco businesses are the first to pull from 2001, 2008 and 2015 collectively and are quickly developing more informed, conservative spend structures that will support them during a down market. NYC is likely to follow suit. Shortly we’ll see the majority of the nation develop a “bunker mentality” — and rightfully so.
In the past, we’ve seen subleases replace leases as solution for businesses in this “bunker” state. When businesses began offloading excess space as a reaction to 2008, teams in the process of looking for space took note. As a result, we saw an increase in businesses absorbing subleases with more flexible terms than a traditional lease. Today, CBRE reports sublease inventory in NYC is at its lowest level since the beginning of 2008 — standing at just 1.7% in Manhattan — evidence of how subleases continued to serve as a vital solution for businesses post-crash.
This time around, our clients have more options. With the influx in flexible office space solutions like coworking and PivotDesk office sharing, we are currently seeing businesses transition from relying on subleases to more flexible options. In comparison to flex space solutions, subleases are still binding and expensive for both parties involved and businesses are well aware of this fact.
Commercial clients demand flexibility
Businesses today are accustomed to paying only for what they need, when they need it. The birth of SaaS (software as a service) and the sharing economy made it so that almost every service a business leverages has a pay-as-you-go (and pay-as-you-grow) model. Combine this fact with the ever-increasing “bunker mentality” due to looming market changes and you start to see why commercial clients are beginning to hesitate on taking sizeable traditional commercial real estate leases. As the down market progresses, we’ll start to see this advance quickly and CRE may see impacts similar to that of Uber on the taxi industry.
“Just like Uber and Lyft have disrupted the hired car industry and Airbnb is upsetting the hospitality industry, the trend of coworking, or shared office space, is revolutionizing commercial real estate,” Law360 reports.
New models have a way of surprising the old
If we learn just one thing from San Francisco’s largest cab companies filing for bankruptcy this year, it’s that when a market requires change and existing solutions don’t do something to fulfill it, customers jump ship at record speeds to adopt a new service that does.
Consider WeWork’s $16 billion valuation. If that’s not a sign of a changing market (one demanding more flexible solutions), I don’t know what is. On top of that, NYC office space provider, PivotDesk, has seen demand for shared space increase 41% this quarter alone.
Traditional leases are binding. They force clients to project far into the future and understand exactly how they will grow and change over time. In many cases that means affording excess space upfront and/or affording excess space should the business have to downsize through the lifetime of the lease. To an agile business employing a “bunker mentality,” that amounts to an awful lot of risk and cash down the drain.
Is WeWork the right solution to alter the industry? Are they the Uber of CRE? No. Their solutions don’t extend to the sizeable commercial clients that drive the CRE industry. But their growth certainly serves as a sign that the market is demanding more flexible solutions — and to that, I say CRE has a big opportunity staring it in the face. The demand for flexible solutions is about to pick up, and those who stay ahead of it (while everyone else is playing catchup) will absorb it.
Brokers don’t have to change how they do business
One fact here is key: Uber did NOT revolutionize the taxi industry; it caused it to evolve. In its simplest form, Uber remains a service where people get paid to drive other people from one location to the next. What’s unique about the service is that they applied an on-demand factor (and ratings to improve customer experience). The on-demand was what the traditional service was missing for far too long. And it’s what allowed Uber to have such an aggressive growth curve almost immediately after launching. Uber responded to the market’s demands while the traditional service ignored them and boom, they absorbed the market.
CRE has the opportunity to learn from this and react to the market’s needs before someone else does. If the market’s core need is flexibility, then it’s time to listen. It’s this exact need that will only be multiplied in a down market, which means anyone who solves for it is ahead of the game across the board.
“We’ve seen first hand how access to affordable office space can revitalize a business community. Our partnership with PivotDesk breaks down the real estate barriers that are restricting businesses looking to expand.” – Michael Philiips, President of Jamestown
The good news? Adding flexibility doesn’t mean starting from scratch. Uber built a solution on top of the structure of the traditional service and we have the same opportunity to do that in CRE. We’re already seeing a few fast-acting groups including TheSquareFoot, Jamestown LLC, Beacon Capital Partners and individuals from CBRE, JLL and T3 Advisors who are working directly with PivotDesk to offer more flexible solutions to their clients.
The question is who will be the first to cement flexibility into their service offerings and harness the opportunity that our changing market presents?
David Mandell is Co-Founder and CEO of PivotDesk
PivotDesk partners with CRE professionals to accelerate deals with non-traditional requirements (for example, a team of 15 looking for space for 1 year). Doing so accelerates what would normally take the form of an expensive, time consuming sublease for both parties. To find out more about how PivotDesk can help you expand your customer base and maintain sales as the market shifts, contact Real Estate Manager, David Miller, at firstname.lastname@example.org | (646) 470-1287.