Amidst the uncertainty of the macroeconomy and a potential recession are geopolitical risks, rising interest rates, and local, state, national, and global political issues. Lying amongst these concerns is the commercial office space market and the impact that work-from-home has had on occupancy, utilization, and its role within an organization.
As a general note, most companies are seemingly functioning with less space today than they did pre-pandemic. This shift is due to many factors, including hybrid work strategies, work-from-home, a mobile workforce that has moved away from the company’s offices altogether, reduced headcount, or otherwise. As no firm rule applies to all industries, only time will tell if this is sustainable in creating, maintaining, and building a culture for innova- tion, employee attraction, and retention.
The Los Angeles office market comprises several submarkets with unique market fundamentals, dynamics, tenant base, and demand drivers. Despite the rising vacancies throughout the LA region, one consistent theme is that the best buildings (both in terms of amenities and quality of product) in the best locations in each submarket are outperforming everyone else. Most of these best-in-class assets are performing better today than they were pre-pandemic regarding rental rates and occupancy percentages.
So, what is driving this demand? There are multiple reasons, but the most common theme is amenities such as food, fitness, wellness, etc., and the desire for companies to offer employees a superior workplace experience. Buildings with updated common areas, plentiful window lines, and better-than-average ceiling heights that provide onsite and walkable amenities are generally doing well. In many cases, tenants are willing to pay almost double to secure a better facility to entice a return to office. Their monthly cost stays the same, but the employee experience improves significantly.
Another challenge in this inflationary environment with rising interest rates is the cost and timeline to construct improvements and the availability of that landlords are will- ing or able to spend on their buildings. Most small to medium-sized tenants do not have the capital budget to spend on their office space, and even if they do have it, they would rather invest those funds into their business where the ROI is much higher. As such, buildings with spec spaces and contemporary finishes ready to go lease first. It can take six to twelve months to build out a simple office tenant improvement today with delays in the supply chain, busy vendors, and permitting with the city. Not every landlord can forward spend tenant improvement money, creating a “haves vs. have-nots” dynamic in the marketplace. All landlords want to lease their buildings, but those that do not have the capital to build out new space are hard-pressed to find tenants willing to agree to the risk of a modest tenant improvement allowance from the landlord and come out-of-pocket for the shortfall.
Whether you are a tenant or a landlord, having the right advisor who understands the local and regional marketplace, competitive landscape, and capital markets is essential to finding a successful outcome in a lease transaction. Nobody wins when unrealistic expec- tations are set. In these uncertain times, transparency and communication throughout the negotiation will help each side understand the other’s position and ultimately help achieve the common goal.
Matthew Heyn is vice chair at Colliers. Learn more at colliers.com.
