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These days, it's harder to trust data on tenant requirements in office markets

This article appeared originally on Bisnow.

Though the omicron variant added yet another wrinkle, the office market in many major cities has seen a recovery in demand based on the tenant requirements that are tracked by brokers.

But that metric may be misleading at a time when long-term planning for office occupancy remains near an all-time low. And what that number means is up for interpretation.

Tenant requirements are calculated differently at each brokerage house and on somewhat varying data, but they generally correspond to a combination of the total square footage of leases expiring in the next couple of years with the size of offices being toured by potential tenants.

Even before the outbreak of the coronavirus, relocating office tenants were more likely to take smaller spaces than they had left, a trend that has only accelerated under pandemic conditions. The average office tenant signing a new lease has been shrinking their footprint anywhere from 15% to 40% on average, multiple tenant-focused brokers told Bisnow.

Making matters worse, the length of the pandemic has entrenched the work-from-home habits and new preferences of many former office workers, while its stop-start nature has caused tenants to re-evaluate their plans over and over again — all contributing to a decrease in reliability of market-level tenant requirement data, especially as it pertains to net absorption, said Cresa President Tom Birnbach, whose brokerage exclusively represents commercial tenants.

“When you look at those numbers, you’d normally think, ‘Oh, there’s positive traction and absorption,’” Birnbach said. “About 80-90% of requirements would have happened in a normal world, but in today’s world, that number is a lot lower. So those data points are a little misleading.”

To an extent, the constantly shifting target dates for office returns and unsettled policies over in-person work requirements has been reflected in how occupiers are conducting their searches for space: a planned move could be off the table suddenly, or a requirement thought dead for months can be revived just as quickly, Longfellow Real Estate Partners Managing Director of Research Lauren Gilchrist said. Before joining the life sciences-focused Longfellow in mid-2021, Gilchrist supervised office research for JLL in Philadelphia.

“The question has become, when is a dead deal really dead?” Gilchrist said. “On many brokerage lists, there are a lot of tenant requirements laying out there that may never happen, and other requirements considered dead that may come back. So like with everything, the pandemic has thrown a whole lot of uncertainty into the mix.”

Some requirements may have been taken off the list due to occupiers taking deals on short-term renewals offered by their landlords to keep occupancy afloat during the pandemic, Birnbach said. Some landlords are even adjusting their tenants’ leases well before expiration to better account for current economic conditions, hoping to tack a couple more years onto the end of a lease term.

“One-hundred percent, there are significantly more transactions taking place years prior to lease expiration to change the footprint and do mark-to-market,” Birnbach said. “So there are a lot more of those transactions taking place since Covid hit, though it is dependent on the landlord. The demand for that from the tenant side is more than I’ve seen in 30 years.”

Some of those short-term extensions signed in the first year of the pandemic may already be expiring soon enough for tenants to pop up on brokers’ radars, while some tenants may be back in the market conducting tours simply because of the massive concessions being offered by landlords hurting for occupancy, said Ernie Jarvis, founder and CEO of Washington, D.C.-based commercial tenant-focused Jarvis Commercial Real Estate.

That story may not be playing out the same way in every market, with some tenants less inclined to bother spending time on a real estate search with the nature of office occupancy still unsettled, said Arun Nijhawan, managing partner at Atlanta-based office landlord Lucror Resources.

“If a tenant is in the market, they’re probably going to take space, but that’s been my personal experience,” Nijhawan said. “The volume [of potential tenants] is less, but the hit rate has been the same.”

Independent of the pandemic, the widening gap between the size of expiring leases and those getting newly signed is also a function of which buildings are landing the most tenants, Nijhawan said. The newest, shiniest properties, ones that companies believe can lure either new talent to the company or current workers back to the office, also offer more common amenities in their buildings than ever before, reducing the need for things like conference rooms, coworking-style spaces and so on within an individual tenant’s footprint.

“If you have a coworking floor with some conference rooms in it, a tenant may feel, ‘Well, I can take 65K SF rather than 100K SF, and on days we need more space, we can use these extra desks or conference rooms,’” he said.

At one of its newest properties, Lucror has been signing new tenants to leases with specific clauses that allow them to downsize their footprint within the first six months, Nijhawan said. While that may not be common practice, and certainly wasn’t for Lucror before the pandemic, it reflects the level of uncertainty still dominating office leasing, even past the stage where a tenant requirement hits the market. At this point, landlords seem willing to do whatever it takes to simply get square footage leased up, even if the final terms of a deal bear less and less resemblance to the top-line numbers that would pop up in a market report.

“Landlords are being super aggressive with concessions,” Jarvis said. “We’re seeing one-and-a-half to three-month rent abatements per lease year, with maybe a slight reduction in face rent, but tenant improvement packages over $100 per SF, which has become the norm for a 10-year deal. So concessions are really high just to fill vacancies.

"Landlords will sharpen their pencils for the first deals they see.”