Like the Pirates code, asking rents are guidelines that landlords and their brokers give tenants as a customary starting point for rent negotiation. But don’t confuse asking rent guidelines with reality.
 
On March 17, 2020, San Francisco issued a stay-at-home order. According to CoStar, average office asking rents on that date in the San Francisco metro market were $64.55/RSF and total availability was near market equilibrium at 9.9%. Three years later, San Francisco has the highest sublease availability rate in the country. On St. Patrick’s Day 2023, market uncertainty caused by the pandemic had more than doubled total availability to a staggering 23.7%.
 
In the slow recovery from the pandemic San Francisco, with a large population of work-from-anywhere friendly companies, sits at the bottom of major metros nationwide in return-to-office rates. That, together with tenants moving to cheaper markets translates to lower demand for office space now, and potentially fewer office workers in the future.
 
Yet, contrary to the market reality caused by the pandemic, landlords have held on tightly to pre-COVID asking rents. On March 17, 2023, asking rents in the San Francisco metro market were down only 4.7% from the stay-at-home order of 2020 to $61.50/RSF. ​
 
The Market Reality
 
For the first time in a decade, tenants have gained negotiating leverage created by two years of pandemic. As tenant representatives we work exclusively with tenants. Never landlords. We recently negotiated a $32.00/RSF direct lease for Class B office space in San Francisco that had a 2020 starting rent of $56.00/RSF. Now, a 42.9% drop in negotiated rent from pre-pandemic may be an outlier but unlike some San Francisco asking rents, it’s to be believed. 
 
Why are Asking Rents out of sync with Market Reality?
 
One of the dirty little secrets of the commercial real estate industry is that most big national brokerages represent both landlords and tenants. It is in the best interest of the brokers representing landlords to keep perceived rental rates as high as possible. Like the Pirates code, these asking rents are guidelines that aren’t to be trusted.
 
Brokers that specialize in tenant representation are only focused on finding value and multiple alternatives for their clients. Properties with unrealistic asking rents tend to come in with higher rent proposals than equal and comparable buildings. Fortunately, some San Francisco landlords are starting to break ranks with their peers and are setting more realistic asking rents. If you find a landlord looking to gouge you on rent before a lease is negotiated, consider yourself lucky to have identified the bad news early. Then, move on to a more realistic alternative.

Whether you are right-sizing or downsizing your office space to support a hybrid working model, there is no easy answer for how much space you’ll need. If we’ve learned nothing else from the pandemic, it’s that we can’t predict the future. An office that supports hybrid working should allow for the flexibility to adapt and change as your needs evolve.  
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It might feel tempting to downsize your square footage to support a hybrid workforce but downsizing and right-sizing are not the same things.
 
Hybrid Workspace Guidelines
 
Prior to the pandemic, open design had replaced cube farms which years ago replaced enclosed large office designs. Companies pivoting to hybrid working models are faced with modifying their open office designs to support more collaborative and flexible workspaces. 
 
A recent HqO report forecasts that by 2025, the need for corporate workspace will flip from 70% individual workstations and 30% collaborative space to 30% individual and 70% collaborative space. The hybrid office design will transition existing office space to flexible desk layouts and hot-desking areas, lounge areas, and meeting rooms designed for videoconferencing with remote working staff, clients, and partners. 
 
Large conference rooms are like dinosaurs in the hybrid office and are being swapped out for more sensible alternatives such as Zoom rooms, huddle rooms, phone booths, and private workspaces that can be made available on an hourly or daily basis.
 
But that doesn't necessarily mean less space.
 
Average Square Footage Approach
 
Prior to the pandemic, organizations would multiply the number of employees by the rule of thumb needed per individual to estimate how large their offices should be. But this calculation no longer works.
 
Today, you may only have 30% of your staff in the office at a given time. A simple 1:1 ratio of desks or square footage per employee is no longer a useful calculation for hybrid office space needs.
 
Space Allocation Approach
 
The Space Allocation Approach is based on how space is used and is more suitable to help estimate the amount of “usable” office space required for your hybrid workspace. Each organization will require a unique blend of these collaborative and individual space elements to support their hybrid working model.

• Open Collaborative Workstations - 60 to 110 sq. ft. per workstation
• Hot-desking areas - 150 sq. ft. per desk
• Huddle Rooms (2-6 people) - 150 sq. ft. per person
• Phone Booths - 30 sq. ft. per booth
• Informal Lounge Areas - 80 to 100 sq. ft. per person
• Video Conference Rooms - 50 sq. ft + 25 sq. ft. per person 
• Large Office - 250 to 400 sq. ft.
• Medium Office - 150 to 250 sq. ft.
• Small Office - 90 to 150 sq. ft.
• Reception Area - 100 to 200 sq. ft. + 10 sq. ft. per person waiting
• Mail Room - 125 sq. ft.
• File Room - 200 sq. ft.
• Lunch/Break Room - 75 sq. ft. + 25 sq. ft. per seat
• Halls/Corridors within the space - 20% to 30% of the total usable area 

 
Note: Any common area load factors (typically between 10% and 20%) will need to be added on to determine the "rentable" area.
 
The Pirates Code
 
Estimate your office space size requirement by the Space Allocation Approach. Then, make sure that you are accounting for planned growth. Make headcount projections for the expected term of the lease. Then, lease space so that around 2/3 or 3/4 of the way through the term you start reaching the occupancy limit.
 
Keep in mind that no two spaces are alike. Look for spaces that are more efficient, like rectangular spaces versus angled corners of a building. No two spaces with the same rentable square footage are the same. Load factor, floor plan and layout matter.
 
These space allocations are mere guidelines. While there are definitive trends in hybrid office design, every organization is different, and you will need to determine the best mix of flexible spaces, collaborative spaces, and private workspaces for your needs. 

         “The code is more what you’d call ‘guidelines’ than actual rules.”
                                – Barbossa, Pirates of the Caribbean

#cre #commercialrealestate #hybridworkspace

Everyone knows someone in commercial real estate. It may be their kid’s little league coach, college roommate, neighbor, relative or someone they sit next to on the commute train. And often, that’s who people work with for their first few office leases. Commercial real estate is a “relationship” business so tenants tend to work with brokers they know. Makes sense.

Until it doesn’t. More than 90% of the commercial real estate brokers represent both landlords AND tenants. This creates a built-in conflict of interest that few tenants understand and even fewer brokers discuss. No one would hire a lawyer who works for the other side. Yet, the equivalent happens every day when tenants work with commercial real estate brokers and firms that also represent landlords. So, ask the broker that coaches your kid’s little league team if they or anyone else in their office represents landlords. If so, you have a built-in conflict of interest.

This conflict manifests itself in many ways. For example, if you find you are getting a worse deal on your lease renewal than new tenants in your building, this is a red flag. Landlords (and the brokers that represent them) know that ~70% of tenants will renew their leases. If you don’t put your landlord on notice that you are considering other options, you’ve lost the negotiating leverage that a new tenant would have. Thoroughly researching your options will give you a Plan B in case you aren’t able to work out an agreement with your current landlord. There is no negotiation leverage if you aren’t willing to relocate. So, treating your renewal exactly as you would relocation will give you the negotiating leverage that a new tenant would have. When your broker suggests asking your landlord for a renewal proposal without first creating leverage for you by getting market proposals, you either have an underperforming broker or a broker with a conflict of interest.

It is in the best interest of brokers that represent landlords to keep perceived asking rates as high as possible and vacancy rates as low as possible. Firms that specialize in tenant representation are only focused on finding value and multiple alternatives for their clients. If your broker isn’t finding you multiple alternatives, then you either have an underperforming broker or a broker with a conflict of interest. 

You may determine that its time to make a change but sometimes its harder and more awkward to cut a poor player that has been on the team for a few seasons than to play the new kid over him. This applies to little league and applies to commercial real estate. Except, do you really want to run your business like a little league team?

As tenant representatives we are often asked by our clients what the difference is between a Request for Proposal (RFP) and a Letter of Intent (LOI). 
 
Reduce Misunderstandings
The RFP and LOI are very similar in that both are merely a discussion of some of the business terms and conditions that a tenant and landlord will need to reach agreement on in advance of executing a commercial lease agreement. The terms and conditions may include but not be limited to: 

• Base Rent (including, escalation, concessions, free rent, and pass-through expenses)
• Base Year
• Term
• Commencement Date
• Delivery Date
• Security Deposit
• Tenant Improvement Allowance
• Assignment and Subletting
• Renewal options
• Signage
• Parking
• Other conditions

RFPs and LOIs are non-binding and will typically go through multiple rounds of back-and-forth negotiations. Upon agreement of terms, the landlord will present a draft of a formal lease agreement to memorialize the transaction. Only a fully executed lease, reviewed, and approved by both parties’ management and legal counsel becomes binding. The benefit of both the RFP and LOI is the reduction of misunderstandings between parties.
 
Maximize Negotiating Leverage 
RFPs are submitted by tenant brokers on behalf of tenants and are often presented in the earlier stages of lease negotiations. LOIs tend to be submitted or exchanged by either tenants or landlords and their brokers closer to final lease negotiation. It is not uncommon for a tenant broker to submit an RFP to a landlord, and the listing broker to respond by presenting an LOI as their response.
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The most significant difference is that a Request for Proposal is a signal from the tenant to the landlord you are considering multiple alternatives and are asking them to put forth their best offer. Submitting RFPs and getting proposals from a select few number of buildings will give you an “apples-to-apples” comparison of alternatives and help you negotiate the most competitive terms and conditions possible with the landlord. There is no negotiation leverage without options and the ability to walk. 
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Unlike the RFP, when a tenant initiates a Letter of Intent, it is a declaration that the tenant intends to enter into a lease with the landlord for their specific premises. Landlords know that nearly all tenants that initiate lease negotiations by submitting a Letter of Intent have vetted their short list and will end up leasing their space.  
 
As tenant representatives we represent commercial tenants only. Never landlords. We utilize RFPs to develop a Plan B in case we are unable to work out an agreement with the landlord. If you don’t put landlords on notice that you are considering other options by submitting a Request for Proposal, you’ve lost the ability to maximize your negotiating leverage.

Many office Tenants focus on the first year “Base Rent” when evaluating their cost of occupancy. Or, as Tenants consider alternatives, they compare the “Rental Rate” per month or year between competing alternatives. However, negotiating the lowest Base Rent doesn’t always guarantee the lowest cost of occupancy. There are many other factors that contribute to calculating the total cost of occupancy. 
 
Calculating Base Rent
 
Tenants tend to look at space requirements in terms of the actual and exclusive space they require inside a suite to conduct business. In commercial real estate terminology this is known as “Usable Square Footage”. However, Usable Square Footage (USF) does not include common areas of a building such as lobbies, shared restrooms, stairwells, storage rooms, and shared hallways.
 
To account for these common areas Landlords add-on a “Load Factor” to the Usable Square Footage to arrive at “Rentable Square Footage”. Load Factor (LF) varies between buildings but commonly ranges between 10% and 20%. If you require a set certain amount of Usable Square Footage, understand that not all office spaces with the same Rentable Square Footage (RSF) include the same amount of usable space that you may require to conduct business.
 
The formula Landlords use to calculate your Base Rent looks like this:

• Useable Square Footage + Load Factor = Rentable Square Footage
• Rentable Square Footage X Rental Rate = Base Rent

 
What’s Included in Base Rent?
 
Most leases in multi-tenant office buildings are “Full-Service” or “Gross”, typically defined as a lease that has one, all-inclusive Rental Rate which includes both the base lease rate and the building standard services which are paid by the Landlord combined into one figure.
 
In Full-Service (FS) and Gross Leases, specified operating expenses “pass through” from the Landlord to the Tenant. These expenses can include any combination of property taxes, insurance, and common area maintenance (CAM). The operating expense amount for the “Base Year” (typically the year of lease commencement or the first calendar year of tenancy) is the maximum amount of expenses the owner will pay over the life of the lease per year. Any expenses over the Base Year amount are passed through to the Tenant in addition to the Base Rent. 
 
In California, buildings that have been owned by the same entities for a long period of time carry a large property tax liability for Tenants. Buildings like these may not have been reassessed at market value for years and in some cases decades. Proposition 13 currently limits property tax reassessments (increases) to 2% annually but allows for full tax reassessments if the building is sold, more than 50% is transferred, or substantial new construction is completed.
 
If a transfer occurs during the lease term, these property tax increases are passed through from the Landlord to the Tenant. It is important to consider that two alternatives with the same negotiated Base Rent may not be the same when you factor in property tax liability and the potential impact on the total cost of occupancy.
 
Escalation Clause
 
It is common practice for Landlords to include an escalation clause in the lease which increases the rate of rent over the term of the lease, usually on an annual basis. The most frequently used types of escalations are Fixed Percent (%), Monetary ($/sf), and Index (CPI). Most leases with a term longer than one year will have escalation. While most tenants want to focus on the first year Base Rent, negotiating a lower escalation clause can have a significant impact on the total cost of occupancy on a long-term lease. The larger the Rentable Square Footage and the longer the lease term, the greater impact the escalation clause will have on the total cost of occupancy. 
 
Concessions
 
Landlords offer concessions to a tenant to make a lease more enticing. These most often take the form of free rent and tenant improvement allowances but may also include free parking, reduced security deposit, and/or consent to sublease. When Landlords offer free rent, it may not actually be free. It's common for Landlords to add the free rent to the end of the lease term which would make a sixty-month lease with three free months a sixty-three-month lease. And, with an escalation clause the Base Rent in months sixty-one, -two, -three will be higher than the initial three months of free rent. 
 
Calculating Total Cost of Occupancy
 
It’s natural for Tenants to focus on the Rental Rate when evaluating their alternatives but as we’ve pointed out there are important other factors that contribute to the total cost of occupancy. The calculation of total occupancy cost is the Base Rent paid by a Tenant over the lease term, adjusted downward for financial concessions paid by the Landlord (such as free rent), and upward for rent escalations and costs that are paid by the Tenant (such as operating expense pass-throughs). 
 
The most effective way to negotiate the lowest cost of occupancy is to hire a broker that exclusively represents Tenants. Why? Because Landlords are focused and experienced negotiators. Landlords that deal directly with a Tenant knows the Tenant may overlook or underestimate the importance of concessions, escalations, and pass-throughs. Like Landlords, Tenant representatives are experienced in complex lease negotiations. But unlike Landlords, Tenant representatives have a fiduciary duty to solely represent your needs. 

One of the first steps in planning for office space is to determine how much space you need. These “rules of thumb” can help estimate the amount of usable square feet required for your business based upon uses.

• DEFINITION: Usable Square Footage (USF) is the actual and exclusive space you occupy inside your suite where you conduct your business. Usable square footage does not include common areas of a building such as lobbies, shared restrooms, stairwells, storage rooms, and shared hallways.

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So far, the math is simple. Determine the number and size of offices, conference rooms, etc... plus an estimate of space needed for circulation (hallways/corridors) inside your suite and you can roughly estimate your usable space requirement. 
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Now that you’ve developed an estimate of the amount of space you’ll need, it should be straight forward to identify the space alternatives that meet your size and budget requirements. But it’s not. Because, while tenants understand and think in terms of their usable space needs and budget limitations, commercial office space is typically marketed as rentable square feet. 

• DEFINITION: Rentable Square Footage (RSF) is the usable (actual and exclusive) square footage plus a load factor (portion of the building’s shared or common areas). Each tenant pays for these common areas in proportion to the amount of space they lease in the building. Typically, commercial office rents are based on rentable (RSF) not usable square footage (USF).

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Office tenants understand that you can’t determine rent without the rental rate and square footage. What they often don't understand is that load factor is the variable in the rent equation used to calculate the rentable square footage.
 

• DEFINITION: Load Factor (LF) is the add-on factor in your rent equation that accounts for the building common areas outside your suite (lobbies, shared restrooms, stairwells, storage rooms, and shared hallways, etc..). Load factors commonly range between 10% and 20%. 

 
The load factor is applied to the tenant’s usable square footage to convert it to rentable square footage.  Understanding how square footage is calculated is essential to determining the best size fit and value for your office space.
 
For example, two alternatives with the same rentable square footage may appear equal but they aren’t. 
 

• Option 1: 10,000 RSF with 20% LF = 8,333 USF
• Option 2: 10,000 RSF with 10% LF = 9,090 USF

 
From a tenant’s perspective, with the differences in load factor (20% vs 10%) you gain 757 usable square feet (9,090 USF - 8,333 USF) in Option 2 versus Option 1.
 
For this reason, it’s important to understand how square footage calculated on your commercial office lease.