Q&A: West, Lane & Schlager on Negotiating With Office Tenants
The COVID-19 pandemic has wreaked havoc on the office market in Washington, D.C., and the entire nation over the past 15 months.
West, Lane & Schlager is a tenant representation real estate brokerage company based in D.C., and the firm’s discussions with current and prospective tenant clients has given it unique insight into how commercial real estate has undergone substantial, and likely lasting, changes.
“Tenants are shocked to learn that many building owners are operating under the assumption that everything will return to business as usual once the vaccine is widely distributed,” said Richard Lane, co-founder and principal of West, Lane & Schlager. “They see few landlords open to structuring leases in a manner that attracts and retains tenants for their buildings as systemic market changes are underway — and we agree.”
That is why many tenants who retooled their operations for remote work are now seriously evaluating how technology might allow them to drastically reduce their office footprints going forward.
“We are strongly convinced of the merits of doing business in person and advocate to our clients on the numerous benefits of physical office interactions,” said Jonathan Danziger, a principal of the firm. “However, many plan to continue to allow their employees to work from home between one and three days per week, and are willing to give up dedicated workspace for this flexibility, depending on the company.”
Commercial Observer spoke with Lane and Danziger about how moving forward to meet tenants’ shifting needs gives owners strategic strength in these uncertain times.
Commercial Observer: How would you characterize the D.C. office landscape as we head towards the summer?
Richard Lane: What we’re seeing in the office market itself, which is as bad as I’ve seen in my 30-year career, is that there’s not going to be a correction in this market for years and the landlords are in deep denial. The Washington, D.C., metropolitan area office market is currently under tremendous distress. The sooner building owners accept and adapt to this changing reality by working creatively with tenants to find mutually beneficial arrangements, the sooner the millions of square feet of vacant space will be leased and create a healthier economic landscape.
What’s the current outlook on the tenant side?
Jonathan Danziger: It’s definitely a good time to be a tenant. Now that we’re about 15 months into the pandemic, it seems like there is some light at the end of the tunnel. Overall, the opportunities for tenants are still unbelievable, as far as concessions go, particularly given the interest that landlords have in trying to retain them. We’re just getting in the mode of trying to figure out what their needs are going forward, which is a little difficult to understand, given the hybrid work model that seems to be the model most people are looking at.
What are you hearing from these tenants? What are their needs as they consider going back to the office?
Lane: Jonathan and I spend our days talking to tenants, and the number one anxiety our clients have seems to be the lease terms. It’s time to reconsider the way leases are structured. The extreme amounts of free rent in exchange for high rental rates, and leases longer than 10 years should be re-examined. Most tenants would prefer a lease with less free rent, an ample tenant improvement allowance and lower rental rates, so the lease does not become above market almost immediately after the free rent period ends. Leases that hold their value longer would go a long way towards attracting tenants — especially smaller tenants — back to the market.
What’s it going to take to attract tenants back?
Lane: You’re talking about an 18 percent vacancy rate, which is about 22 million square feet, in a market dominated by smaller tenants — less than 20,000 square feet. They need to get the tenants engaged. What the tenants really want are deals with lower rents and more flexible lease terms, so they don’t have to commit to 12 or 13 years, and they have options for space contraction and lease termination.
What do landlords need to be thinking about?
Danziger: We understand the landlords have restrictions and investor demands, and they can’t take a $65-per-square-foot building and price it at $55 per square foot overnight — but they need to start thinking about how to do business differently and need to start thinking about how to reposition their product, so it’s attractive to the fat part of the bell curve and not just the high-end tenants.
What are some of those solutions? What do you recommend they do?
Lane: First of all, tenants would be more attracted to lower face rates in lieu of a ton of free rent. The nonprofits and trade associations, for example, are a huge part of our market. When they get free rent, they have to account for it over the term anyway. Plus, they are very regimented and have budgets, and their boards and donors expect for them to have to pay rent. What does something for them is a lower rent, which would mean a lower escalation and the lease term would hold its value longer. It would be good for the landlords, because they would get cash flow much faster. Flexibility is also important. If tenants have options to perhaps shed some space over time, that would make them most comfortable.
How will spec suites play into all of this?
Danziger: Spec suites have been welcomed by smaller tenants who want more flexible lease terms, and to avoid the lengthy design and construction process. Owners should expand this program and build a more diverse mix of spec suites suited to accommodate larger — 7,000- to 10,000-square-foot — tenants as well. These tenants are becoming amenable to pre-built suites that offer more flexible lease terms.
So, with all that in mind, what do you expect we’ll be seeing at the end of 2021?
Lane: It’s going to look like it looks today. Before the pandemic, the vacancy rate was 14 to 15 percent, depending on what source you saw. That was as high as it’s ever been and it really never came down from the recession. So, having a record vacancy rate before the pandemic, and now it’s three points higher and demand is off, you would need demand like you’ve never seen to fill that space. The positive absorption numbers you need to put a dent in this market are so mind-boggling. You need to look at a much longer horizon than the end of 2022.