Thursday, January 25, 2024

Startups slashed office space during the pandemic. That spending isn't coming back.

 By Andy Medici – Senior Reporter, The Playbook, The Business Journals

Startups dialed back their spending on office space during the pandemic, and they're likely to continue to spend less for real estate in the years to come.

That's according to research from accounting and finance firm Kruze Consulting, which found that about 65% of startups paid rent before the pandemic, but that figure dropped to below 40% in 2021. The percentage has since rebounded to a bit under 60%, but the amount being spent on rent as a portion of a company's overall expenses has fallen from between 7% and 7.5% before the pandemic to about 2.5% now.

The data draws from more than 800 startups served by Kruze. It also shows how quickly and thoroughly startups cut down on office space during the remote-work boom of the pandemic.

“It appears that this is the new normal," said Healy Jones, Kruze vice president. “The percent of startups that are going to pay for an office is down. I don’t see anything changing that unless there is some dramatic change.”

Jones said the rise of remote work played out well for many startups, as startups tend to be more flexible with remote arrangements than larger, more-established companies. The reported numbers also reflect how the office rents are lower in many cases than before the pandemic, meaning the expenses take up less of a company's overall budget.

Rents have begun to creep back up in the last few months, but Jones said there's a larger issue to watch: Startups are going under, and while they might try to reduce expenses to stay afloat, rent is the hardest budget line to cut.

“This is like a 'dead-cat bounce',” Jones said. “This is a warning call for landlords that there is going to be a lot of bankruptcies in the startup worlds as companies go under.”

What startups want for office space

Startups in the future will be more judicious about office space, Jones said.

That doesn’t mean companies will abandon it altogether, as many startups need lab, manufacturing or even call-center space for their businesses — and some of those spaces are in short supply. 

But it’s far less likely startups are going to be spending precious dollars on generic office space in urban downtowns, Jones said. The open-office concept that became popular in recent years is a poor environment for a software engineer writing lines of code — and employers who can manage workers remotely likely will opt to do so going forward, in turn saving money on a lease.

Jones’ advice for business owners who are looking to lease space? Be strategic. Think about the culture you want to build, whether remote, in-person or hybrid, and what that means for your needs. Also think about where your employees live and locate your office accordingly.

“Individual employees are thinking a lot about their commute,” Jones said. “Employees aren’t against seeing each other in person. They just don’t like sitting for two hours in their car every day.”

Challenges for the U.S. office market

The Kruze Consulting data highlights a difficult position for the nation's office-market sector.

More than 800 million square feet of office space is set to expire between now and 2028, according to a recent analysis by commercial real estate data, analytics and valuation platform CRED iQ. At the same time, there is about $321 billion in commercial real estate debt set to mature in 2024 and 2025, by CRED iQ's estimation.

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

Meanwhile, startup funding fell back toward its pre-pandemic levels last year, according to data from Pitchbook and the National Venture Capital Association. Startup funding fell to $170.6 billion in 2023 from $242.2 billion in 2022. That's also down from a peak of $348 billion in 2021 but above the $149.4 billion that was reported for pre-pandemic 2019.

Startups are facing a more challenging interest-rate environment than in years past, as well. The Federal Reserve kept the Federal Funds rate near 0% for a number of years prior to 2016 before slowly raising that benchmark to above 2% just before the pandemic — and then lowering it once more. Starting in 2022, the Fed once again raised the Fed Funds rate to combat high inflation and wage growth, with the rate hovering above 5%  — the highest it's been in more than 20 years.

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