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September 2013 Newsletter
September 2013 Number 1

How Much Space Do We Need?

Will shrinking footprints slow the office recovery?


No company ever seems to have the right amount of office space. Firms grow and shrink throughout the years for many reasons; however, they must contract for space over a set lease term of five, 15, or even 20 years. Typically this situation results in about 20 percent to 25 percent more space per worker than the stated goals of space planners. So firms with a goal of 200 square feet per worker will likely end up closer to 250 sf per worker.

Yet, in last year's CoreNet Global survey, corporate executives indicated they expect to reduce the amount of space they lease in the next five years to less than 100 sf of dedicated space per worker. Since the current average rentable building area in the U.S. is about 300 sf per worker, does this mean we have three times as much office space as needed?

 

Current Space Trends

Looking at square feet per worker on new leases, the U.S. national average in late 2012 was 185 sf per worker, according to CoStar lease data. This number reflects new leases in major markets and a fairly tight economic environment. Company executives do not want to lease too much excess space even though they may find current rental rates are attractive. Comparing utilized space by industry (see chart) reveals consistent differences that are reflective of an industry's compensation level and need for work space.

 

As of 2013, on leases close to expiration, the average space per worker is often double the estimate for new leases. This makes sense, since companies can't downsize until leases expire. In soft economies we expect a fair amount of shadow space that is leased but not occupied. Since labor costs matter much more than occupancy costs, most tenants are able to honor their leases until they expire, so they pay for more space than they actually need. The extra space also provides a convenient option to expand and hire more workers without the need to move. So we expect to observe significant extra space in weaker economies, when rents seem to be bargains.

 

Future Space Needs

A survey conducted by the author suggests that everyone wants to use less space. Large firms, representing about a third of all office space users, have increasingly moved toward more-standardized shared, or nondedicated, office space. Based on input from CoreNet Global members and CBRE tenants, tenants with footprints greater than 75,000 sf are working harder to use space more efficiently. This group tends to encourage digital storage on centralized cloud-based servers and use nondedicated standardized space for all but the most senior of managers. This group represents 1.8 percent of all U.S. tenants by coun

t and 27.9 percent of all office space.

 

Those using more than 50,000 sf represent 36 percent of the total office stock. If, using some of the space-sharing strategies described above, 36 percent of the firms reduce their primary leased office footprint by 50 percent, moving from 250 sf to 125 sf, this would be the equivalent of 540 million sf out of some 12.25 billion office sf as of 2013. Historically this is equivalent to 3.6 years of average U.S. deliveries of net new office space to the market, which has averaged close to 150 million sf per year since 1983. At the same time we recognize that little space has been added from 2009 through 2012 and the office stock has actually shrunk due to increasing obsolescence. Absorption has been positive for the two years prior to the end of 2012.

 

Along with companies' higher space utilization rates, other factors are affecting future office space demand. The lack of new construction inhibits space use efficiency. Newer buildings allow for more-efficient use of space, especially when built for a particular tenant. But as the lease ages, the amount of space leased and the number of workers in the space generally changes, resulting in increased space per worker. As second-generation tenants replace first-generation tenants, it is often more difficult to use the space as efficiently. This is generally the case for most small firms that cannot, on their own, drive new supply in the market.

 

Looking at the global market, office space per worker is much less in Europe and Asia than in the U.S., suggesting some of U.S. demand is culturally based. Thus, as the U.S. companies are influenced by companies and employees from other countries, office configurations and work space allocations per worker may change.

In addition, the increasing mobility of U.S. office workers who may work full or part-time from other locations, is causing companies to reconsider the need for dedicated office space for every employee.

 

Companies are also increasing the proportion of collaboration and team space in offices, along with more space devoted to amenities. These flexible spaces are offsetting some of the square footage lost to smaller dedicated work spaces. We are also witnessing an increasing trend toward greener office space with more natural light, better natural ventilation, and better temperature controls, all of which may add to the comfort and productivity of office workers.

Over a longer term, the average size of space leased has fallen by 21

percent during the past 10 years, according to a Property Portfolio Research September 2012 report. PPR also notes that green, transit-friendly space is increasingly in demand, suggestingthat much of the existing space is obsolete and needs retrofitting. Those buildings that are able to bring in more natural light without extraordinary costs seem to offer the best opportunities for retrofitting.

 

Decreases in total office consumption based on more-flexible work location patterns and higher utilization rates are underway, but they take time. The total demand for space will grow at a slower pace for the next few decades, as firms decrease space allocated per employee, but there will be substantial demand for better interiors more adapted to the newer style of working.

 

Over the next several years we will likely see a large spread in the space required per worker from the most efficient space users to traditional space users, so estimating the average sf per worker will be a challenge. The most reasonable estimates presume a continual but slow reduction in space per worker. For now, 200 sf to 250 sf per worker is still a reasonable estimate for most traditional firms, but at the same time, 100 to 150 sf is closer to what some of the larger public firms are now achieving.

 

Moving forward, we will see some firms achieve less than100 sf per worker, but given the cultural impediments and the challenges of predicting growth rates, we are more likely to see figures average 150 sf to 185 sf per worker phasing slowly toward even lower figures at the end of the decade. This is a significant reduction in space per worker, but it parallels a need to retrofit much of the existing space to provide more collaborative team space and healthier, more productive environments.

At the end of the day, landlords are not selling space but rather productivity. More productive environments with better natural light, temperature and air controls, cleaner air and controllable noise are more productive and will command rental premiums.

 

Reprinted from Commercial Investment Real Estate Magazine, article by Norman G. Miller and Roger J. Brown, CCIM, May-June, 2013

British American Tobacco headquarters in London

(Reuters) - After decades of renting being the norm, companies with offices in the world's major cities are seeing more financial sense in buying their own buildings, prompted by a mix of cheap debt, stockpiled cash and new accounting rules.

 

Having culled staff in the wake of the financial crisis, businesses are now scrutinising real estate costs and capitalising on an opportunity not present for at least half a century to cut what is often their second-highest outgoing.

 

As central banks keep interest rates historically low to kickstart economic growth, the resulting cheap cost of borrowing ends "fifty years of perceived wisdom" that companies shouldn't tie up cash in property, said Chris Simmons, founder of Real Estate Forecasting.

 

There was a fivefold increase in the value of occupier deals in London last year versus 2011, a tenfold increase in New York and a sevenfold increase in Hong Kong, data produced for Reuters by research company Real Capital Analytics shows.

 

Among companies that have recently bought their own real estate are WPP Group and Google in New York and Manulife and Hang Seng Bank in Hong Kong, according to RCA data.

 

"We are at a moment in time when all the planets are aligned for companies to buy property," said Chris Lewis, a real estate advisor at accountant Deloitte. "The idea is starting to gain traction and you'll see a sustained increase over the next several years."

 

Cigarette producer British American Tobacco, which bought its headquarters on the north bank of London's River Thames for 190 million pounds ($298 million) last year, described the deal as "financially attractive".

 

The rental yield of about 5.5 percent, or the annual rent as a percentage of the property's value, was more than double its current ten-year corporate bond yield of 2.4 percent, according to Thomson Reuters data.

 

In other words, if it funded the purchase by issuing ten-year bonds, the annnual interest bill would be less than half the annual rent bill, a saving that would come on top of any future rise in the property's value.

 

Such office deals are "at unprecedented levels" due to cheap loans as well as the cash many have hoarded in choppy economic times, said Robert Matthews, head of international real estate at Scottish Widows Investment Partnership (SWIP), which has 8.2 billion pounds of property under management.

 

"We recently sold two properties in greater Paris for exactly these reasons," he said.

 

Proposed changes under International Financial Reporting Standards expected in 2016 or 2017 could strengthen the case for ownership. Under the new rules, all outstanding payments over a lease's term must appear on the balance sheet. Currently, only the annual rent goes through the profit and loss account.

 

The appearance of larger liabilities may affect how a company is viewedby lenders and ratings agencies and hurt its ability to borrow, said Michael Evans at real estate consultant Jones Lang LaSalle.

 

"The changes give property costs a higher profile in the minds of CEOs and FDs," he said.

 

Buying is not always an option and wouldn't work for a building with several tenants, for example. Other companies would be reluctant to tie up cash in such long-term deals, particularly those with smaller cash holdings or that need it for more pressing issues like overseas growth or acquisitions.

 

If problems arose, companies would also be hit by the double impact of a business doing badly and a property that drops in value because it houses a financially shaky tenant.

 

Overall property costs are typically between eight and ten percent of total costs but can be shrunk by squeezing more staff into re-configured space.

 

Efficient designs which can save companies millions, are a major selling point of new buildings like Land Securities' Walkie Talkie skyscraper in London.

 

"Real estate decisions have become a board level issue and are no longer the preserve of the property manager," Lewis said. "Most FTSE 350 companies are taking a long hard look at their property costs."

 

 

Reprinted from Reuters article by Tom Bill , June 21, 2013.

Southwest and Northeast are Top Expansion Markets

 

Fifty-eight percent of commercial real estate industry executives expect their company to spend more on geographic expansion during the coming year, according to KPMG LLP's 2013 Commercial Real Estate Outlook Survey. In last year's survey, only 21 percent of respondents expected an increase, up from 11 percent in 2011.

 

The Southwest (45 percent) and the Northeast (36 percent) topped the list of U.S. regions with the best commercial real estate investment opportunities, while Latin America (32 percent) and Asia Pacific (21 percent) led the non-U.S. regions.

 

"Market expansion is an important focus for commercial real estate executives as they strive to grow the top line," said Greg Williams, national leader of KPMG LLP's Real Estate practice. "Domestically, the Southwest and Northeast are attractive markets because they are experiencing higher job and economic growth and thus have experienced a faster recovery, with property prices in submarkets within these regions at or above pre-recession levels."


Read the full report at: http://www.ccim.com/newscenter/323084/2013/07/02/southwest-and-northeast-are-top-expansion-markets#sthash.4ERf7ALw.dpuf

 

Reprinted from CCIM Institute, CCIM.Com Newscenter, July 2, 2013.

Cap Rates Continue to Decline

 


Although capitalization rates continue trending downward, according to PricewaterhouseCoopers' second quarter Real Estate Investor Survey for 2013, commercial real estate remains a very attractive investment option for both domestic and inbound investors. This is due in large part to continued low interest rates and lack of comparable alternative risk-adjusted investment options.

Commercial real estate remains a very attractive investment option for both domestic and inbound investors, due in large part to the continued low interest rates and lack of comparable alternative risk-adjusted investment options, according to PwC's 2Q13 Real Estate Investor Survey.

 

Among the 34 markets highlighted, the combined overall capitalization rate fell to 6.91 percent in 2Q13, according to the report. The aggregated rate, which excludes the hotel, development land, and secondary office sectors, sits just four basis points above the lowest combined average since 1997. Cap rate compression combined with the unpredictable economy and slow commercial real estate recovery has spurred concerns about overpricing in some sectors and markets, according to the report.

 

While the disparity between office rent growth projections and cap rate compression is unevenly dispersed across the U.S., cap rate declines and initial-year rent growth forecasts in the apartment and warehouse sectors have moved "more in sync" with current and projected fundamentals in most of the U.S. metros surveyed.

 

"Cap rates are still trending downward, but the improving dynamics of these sectors, and not just cap rate compression, are helping to restore values, which should benefit property owners when cap rates inevitably rise," according to the report.

Reprinted from CCIM Institute, CCIM.com Newscenter, June 28, 2013

 
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