Companies will have to ask tough questions in office-space negotiations in 2024

 By Ashley Fahey – Editor, The National Observer: Real Estate Edition, The Business Journals

The calculus for companies in the market for office space has become significantly more complicated in the wake of the Covid-19 pandemic.

For one, it's been tough to get workers to return to the office, although 2023 has seen a more robust comeback, as a greater number of employers mandate in-office time at least a few days a week. Still, to lure a reticent workforce and "earn the commute," company leaders have had make their workspaces more compelling and amenity-laden.

For another, companies are facing higher costs of everything, especially borrowing, and the economy is widely expected to slow in 2024. This year saw more layoffs and hiring slow in certain sectors as companies reassessed their expenditures, although the labor market remains tight.

Heading into 2024, business owners and managers making decisions about their office space — whether out of necessity, such as a lease expiring, or driven by factors such as recruitment — will have a few notable things to consider.

High-stakes environment

One of the biggest changes in office-space negotiations, experts say, is an expectation of more landlord transparency — especially their financials.

There's an estimated $47 billion in office loan debt coming due in 2024, according to Moody's Analytics Inc. Among commercial mortgage-backed securities loans backing office properties, Moody's estimates three-quarters of that will struggle to refinance next year.

"We’re seeing the same themes over and over again for tenants, corporate users and even small businesses: They want to reduce risk. What is the risk of doing a deal with a landlord that’s maybe on shaky ground?" said Michael Lirtzman, head of U.S. office agency leasing at Colliers International Group Inc.

There's a lot potentially at stake if a company signs a medium- or long-term deal at a building that'll face issues when its loan matures. Distressed buildings could be taken back by their lender, throwing tenants into chaos and uncertainty. Some landlords are even giving the keys back on buildings they no longer see as financially viable to retain.

Tenant brokers today frequently are advocating for subordination, non-disturbance and attornment (SNDA) clauses when their clients are signing an office deal, said Giles Wrench, vice chairman of financial services at Jones Lang LaSalle Inc. Those agreements spell out the rights of the tenant, landlord and any interested third parties — a lender or other investors, for example. Such clauses could prevent a tenant from being evicted if the building goes into foreclosure.

"There's a tremendous focus on that in the moment," said Wrench, who works with large financial-services companies and banks on their leasing strategy. He added office-space decisions and lease negotiations have gotten down to the micro level with tenants because of the current state of the office market.

In fact, the CEO is almost always on the ground floor of real estate decisions today.

Companies both public and private are under immense pressure to exercise financial scrutiny, Redmond said, and building the business case for a real estate decision is "under a big spotlight."

"There’s a need now more than ever before to really do due diligence around real estate decisions — understanding where your business is going, aligning with expectations and being really sharp on how you’re coming to the negotiation table, even at the individual-deal level," Redmond said.

Asking questions earlier in the process

Before a deal is even close to being signed, brokers say they're having to exercise more scrutiny on behalf of their tenants, and they're doing so earlier in the process.

Redmond said with companies her team works with, there are questions in requests for proposals to landlords about a building's capital stack, to try and gain a clearer picture of things such as a property's financial condition and whether there's an upcoming loan maturity.

On the whole, landlords that are in a relatively stable position financially are willing to share those details, brokers say. For landlords that aren't as transparent, those buildings might be eliminated in a space decision.

"It’s a massive red flag if you run into a landlord that’s being opaque," Wrench said, adding many companies, especially highly regulated ones like banks, can't afford to take on that risk.

David Lipson, president of Savills North America, said in an interview last month that companies and brokers should not only look into the capital stack of a building or the limited-liability company that owns it, but they should examine the parent company's financials as well. And a loan doesn't need to be coming due tomorrow to be a potential problem, he said.

"You can have a landlord sitting on a billion dollars of cash, [but] it doesn't mean they're going to put any of it into a given asset," he said.

Colliers' Lirtzman, who primarily works with landlords, said the smarter tenants and brokers are asking questions much earlier in the process. For landlords with a strong capital stack, those questions are welcome, he said.

Redmond said it's also imperative that companies in the market for space understand the capital markets, which will help them make more-informed decisions.

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