(Editor’s note: The following is a Q/A with R. W. Holmes Managing Director Dean Blackey on an overview of office lease renewals and terms in Greater Boston.)
Boston Real Estate Times: What is happening with office lease renewals in the post-post-Covid era?
Dean Blackey: I think the important thing to understand first is that the lease renewals are following the same path they were during COVID, which is interesting. It’s a trend that we thought would go away. Well, it’s all tied to the fact that obviously, during COVID, nobody had anybody in the office. Nobody knew when people were coming back. And, you know, the tenants didn’t know what to do. Landlords didn’t know what to do. So, they kind of kind of got together and said: Hey, listen, let’s not make any rash decisions here. We will just renew the lease for another year; let’s get through COVID and see what you need. And I think everybody did that.
Prior to COVID, when the market was good, space was tight, and a tenant space was coming up, a landlord was really in the driver’s seat; they would say: Hey, listen, you know what, this needs to be a five-year renewal. Or, you know, it’s just not going to work out. It needs to be more than what you were paying last year, and it was basically dictated on the landlord’s terms.
BRET: How is the dynamic now?
DB: The dynamics have changed because, during COVID, people figured out that employees can work from home, anywhere.
BRET: So, how is that factoring into the lease renewals now?
DB: What we thought was that when COVID was done, everybody would go back to the office, and we would go back to the way we were before COVID, where the landlord was in the driver’s seat, and a tenant was basically dictated by the landlord’s terms. But considering the whole work-from-home phenomenon that is happening, tenants have multiple choices and maybe even on better terms and with more flexibility.
BRET: So, how are landlords responding?
DB: What’s happening is landlords are continuing to adopt that same mindset from before; ‘I need to keep this tenant in the building because of the cost to me if I lose them, and I forced their hand by saying, no, it’s got to be a five-year deal.’ And no, it’s got to be more expensive than you were before. It’s going to be the breaking point for them. And they’re just going to say, hey, you know what, you know, all landlords are concerned that at any moment, their tenants are just going to say, I’m just going to go work from home. And so that’s a concern of a lot of landlords, which never was the case before. It was like, well, either renew with me or you go to another building. There was never the third choice, which is, you know, what, maybe we’ll just have everybody work from home. And we’ll just close this office down entirely. Landlords are terrified of that. Now, tenants are in the driver’s seat. And landlords continue to be a lot more flexible on things like terms and sizes.
BRET: What is your advice to landlords?
DB: We tell landlords that if somebody comes to you, and they’re a decent part of your space and a good tenant, don’t be afraid to do a one- or two-year lease or something like that. You don’t want them to make a rash decision where they say, ‘alright, well, you know what, I’d prefer just to kick the can down the road and wait to see if I can get more people back in a year. But if you’re telling me my only choice is to commit for five years, well, then I’m just going to walk away.’ So, we’re telling landlords to continue to triage the situation, talk to your tenants, figure out where the pinch points are, and try to be as accommodating as you can. Because, you know, if a tenant walks out of your space, the time it takes to backfill that space can be six months, it can be a year, it could be two years.
BRET: How are the tenants renewing? Are they renewing the lease for the entire space or cutting it down?
DB: A lot of tenants come to us and say, listen, I just don’t have everybody back in the office right now. I want to renew the lease. But I’m in 10,000 SF. And I only need like 8,000 or 7,000. We want to keep these guys, but if we go in and physically subdivide the space, that’s going to be with construction costs where they are, and that’s going to be an added cost. The space that we subdivide off the remaining, call it 2,000 square feet, it’s probably going to sit there for a while. Why don’t we allow them, and we’ve done this with several tenants? Why don’t we reduce their rent so that they’re only paying 8,000 square feet, but let’s allow them to stay in the 10,000 square feet for the time being? And then when we do find a tenant for that space, we’ll cross that bridge when we come to it, and then we’ll physically divide the space.
BRET: How does it compare with the early 1990s market?
DB: Well, you don’t want to remember that. In the early 90s, when we had a deep recession, and you know, the real estate market was really at the bottom. Even at that time, this didn’t happen.
BRET: Are you advising against subdividing vacant space in this market?
DB: Imagine just how expensive construction costs are now. If it was years ago, and you were in 10,000, and you only needed five, to put up a demising wall would be easy. Not these days with code and everything like that, and it’s separately metered and sprinkler heads and everything like that. Simply subdividing a space can be, you know, ten bucks a foot. And if you do that, before you have anybody for that empty space, why put the horse before the cart? This is not true for every office building, but I would certainly say if it’s a building where you have other vacant space that you’re trying to fill anyway, why create more vacancies? Why not just let the tenant, you know, work something out with them? And who knows, maybe a year goes by, and suddenly they have more people coming back, and you notice that they’re using that space more, and then you can ramp them back up to 10,000 [square feet].
BRET: How much office space is being reduced on average?
DB: It’s hard to put our finger on, exactly. An interesting trend before was that we didn’t see tenants reduce their space right out of COVID. We thought everybody was going to cut their space in half because they’re just not using it. What happened was that business owners realized that they were cramming their employees in too tight before. They said they needed the same amount of space because they now needed to spread everybody out. So even though half the number of bodies are coming back to work, I’ve got to create an environment where people are more spread out. And so, they kept the space that they had, but they reduced elements like the cube amount.
However, since then, now with the work-from-home thing, even if they have the same number of employees, what they’re doing is people are coming in on certain days. One contingent of people is coming in, and they’re using those cubes from maybe Monday and Fridays, and another group is coming in Tuesday, Wednesday, or Thursday, or whatever. But a lot of them use the same cubes. They’re kind of going back to that hotel concept, I remember.
BRET: Are you surprised?
DB: I would say that after COVID, there was very little reduction, and we were shocked by that. But now that the work-from-home has been here to stay for a while, things are different. A lot of tenants are reducing their space because, but they’re going to, as we say, the ‘hoteling’ thing.
BRET: Give us a number on space reduction.
DB: I would say the average is probably 25-35%. It’s hard to say that because not every tenant can just wave a magic wand and reduce their space by 25%. I would say the average is probably 25%, with some of them being as much as 50% cutting there.
BRET: How are renewal terms changing?
DB: Earlier, it was five years, and five creeping up to seven. And now it’s unheard of, at least for a renewal. A new deal is different. But for renewal, there’s a lot of landlords who say, ‘Hey, listen, how about you start at five years?’ And they’re like, ‘No way. We just don’t have a crystal ball to know what’s going on here. What about three years?’
BRET: What is your advice to tenants right now?
DB: I would say to the tenants, don’t be afraid to be honest with your landlord and tell them upfront what you want. A lot of tenants think that they have their cards and, sometimes, they’ll come at the last minute to the landlord when their renewal is coming up and say, ‘Hey, listen, you know I really can’t afford to be in this space anymore; I’m swimming in it, there’s too much space.’ A lot of landlords would listen. Don’t be afraid to say, ‘Hey, listen, I just paid 10,000, and I only need five. What can we do?’
BRET: What is the impact of flight to quality on renewals?
DB: I think it’s more pertinent in downtown Boston than anywhere else. I think the bottom line is that the tenants are in the driver’s seat more now than I’ve ever seen in our lifetime.
