Tenants have got a really great opportunity to take the upper hand in lease negotiations and capture favourable items not just at the start of the lease, but for the whole duration of a commitment.
Rebecca Kent
There are a lot of businesses right now that are adjusting their offices and tightening their real estate costs as they shift to meet this explosion in flexible working.
So when office markets are turning undisputedly in their favour, what exactly are all the options business have to choose from? Or better still, which of those options will help them get the best out of their workforce, and agree with their balance books?
Here are two people that are helping businesses do exactly that.
Jessica van Raay
Jess van Ray, I'm a director in the JLL tenant representation team based out of Melbourne. I've been working at JLL for 13 years advising corporate and government occupiers on their leasing requirements.
Dirk van Velden
Dirk van Velden from JLL tenant rep here in Brisbane. I have been with JLL for just over 10 years now, I originally started in leasing, and then about seven years ago, switched over to our tenant occupier advisory business. Similar to Jess, I’m working with a range of corporate, private and government organisations.
Rebecca Kent
I’m Rebecca Kent, host of this JLL Perspectives podcast. With the help of Dirk and Jess, we’re covering how businesses are weighing up their office options for a perfect fit … even when the future is so ridiculously hard to predict.
Jess, I'll start with you. What does it mean, when the market is favoring the tenant or favorable to the tenant? What are we seeing play out? How is that different to what we've seen? Sort of fairly recently in the past?
Jessica van Raay
So when the market is in the tenant’s favour, you can really find that tenants have the opportunity to take the upper hand in the lease negotiation. The market conditions for a landlord - they might have higher vacancy, they might have expiry profiles that they're building is going to potentially have longer letting-up periods, and they'd be wanting to hang on to tenants as well. So, if a tenant sits back and can assess what's playing out in their market and use that to their opportunity in their planning time, to allow enough time for a more strategic negotiation, it’s really great opportunity for tenants to secure far more tenant-favourable terms. That’s not just going into a lease, but also for the course of that whole lease. So, if it's a five or seven-year commitment, we want to help tenants capture the tenant-favourable items along that journey of the lease. It's not just getting a great deal at the start.
Rebecca Kent
To what extent are you seeing that, and have you been able to leverage those favourable conditions?
Jessica van Raay
The past 12 to 18 months, if we look back to the end of 2019, Melbourne vacancy was sitting around that six percent mark, and it's pretty much doubled that during COVID. There have been a lot of corporates pull out of office space altogether, or they're yet to even return to work. We've also seen a lot of sublease space into the market. So landlords have not only got direct space to deal with, but they're also competing with their own tenants and occupiers who are looking to offload their lease obligations potentially at a far more discounted rate than what a landlord would be would be looking to achieve on a direct basis. So, that's all playing into the advantage of the tenant at the moment because landlords are looking to hold on to what tenants they have, as well as mitigate their vacancy and expiry profiles into the future.
So what COVID has done for a tenant as well is enabled them to get far greater lease flexibility. Traditionally, five or seven-year lease terms were expected for a tenant going in. But now it's three-year leases, expansion and contraction rights are far easier to achieve in a post-COVID world. Right now, occupiers are thinking, ‘I can't even look three months ahead, let alone what my office requirement is going to be in three or five years from now’.
Rebecca Kent
Dirk, is that what you're finding some of the challenge is - as Jess was saying, just to knowing how things are going to pan out in the next three to five years?
Dirk van Velden
Yeah, I think so. Some of the larger occupiers we are talking to, looking three years in advance is a challenge. These are typically groups that would come to the market three to five years before their lease expires because they are normally in the pre-commitment market. So that's going to be a challenge in terms of when they activate and forming a view as to their office footprint and how they're going to use it longer term. For some of smaller occupiers - I'd say probably the sub-1000 square metre market, I think they’re going to be fairly active. The reason for that here in Brisbane is we've got a mix of good quality fitted options. Landlords have built speculative fit-outs as well. So they’re being pretty competitive on those deals.
We've had one engineering client, who recently reduced their footprint as a result of COVID. The original deal for this particular building was on a whole floor, but they didn't need the whole floor anymore. So the landlord has come up with a deal structure where we would take probably about three quarters of the floor - so 500 square metres of a 650 square metre floor plate. But we've got a fit-out to be delivered for them by the landlord, an additional incentive in a rent abatement to reduce the rental cost, and then additional flexibility. So we can break the lease and the end of year three with no penalty. And we've got a first refusal over the balance of the tenancy that's going to be left behind on that floor in case the growth that they're looking to achieve comes through. So a lot of flexibility for that particular client.
Rebecca Kent
What are the things businesses are unsure about, specifically? Is it how the economy is going to go? The headcount of their workforce? How working styles are going to evolve?
Dirk van Velden
I think that's industry-specific. So some industries as a result of COVID have performed really well, and others are lagging a little bit. So it's really dependent on that user. I think it's more about how they're going to use the space longer term. Some businesses aren't even fully back in the office yet, and there are stat- by-state based impacts as well.
I know for some of our clients here in Brisbane, they are U.S.-based and the direction from their particular headquarters is ‘don't come back into the office, regardless of what flexibility is available. Within Melbourne, it’s obviously slightly different in terms of its timing and impacts. But yes, it is a challenge to plan. The other thing that comes into it is how the staff view that re-entry into the office, because some organisations have found that more challenging than others, that is, convincing their staff to actually come back to the office.
Jessica van Raay
Talking to some of my clients over the past couple of weeks that have got expiries into next year and the year after, the challenge is last week they could accommodate 300 people at 50 percent or 75 percent. But their swipe cards are showing 10 people are turning up at the moment. So really their biggest challenge is how do they entice people back.
In Melbourne, everyone's probably a little bit traumatised after our extended lockdown. We had a snap lockdown a few weeks ago, too. So there is a real nervousness across the general population. We don't want to go back to that. But it's all about how they can demonstrate and celebrate people coming back in to try and get that confidence back.
I think a lot of the data and research out there is showing that 70 percent of workers do want to return to the office in some capacity. But that conversation has to be had about the hybrid working style. So, you might say ‘I'm going to come in two or three days a week, but is everyone going to be in the office on Tuesday or Wednesday? How do I manage the space and manage low occupancy on maybe a Monday or Friday?’. Human behaviour is really hard to predict right now. For the tenants who are going to reinvest in their office fit-out or are able to make a move in the coming years, a lot of that office occupancy and data utilisation is going to play a key part. By embracing technology, they can monitor who's coming in, and that could then feedback to facilities management on cleaning requirements and managing heating and cooling. That's a big cost, especially if you've got all the air conditioning going and you've only got 10 people in the office.
Rebecca Kent
Dirk, if you've got a tenant saying, ‘I don't feel like we're making the most out of this space and we recognise that there are better opportunities out there for us’. How do you choose between say, subleasing space, surrendering a lease altogether, or something else? Tell me the process you go through in weighing up which is the best option.
Dirk van Velden
To decide to sublease space, you need to know that you've got excess space to give away and that it's easy to do. I think some groups fall into the trap of saying, ‘well, half of my floor is empty and so I need to try and sublease it’ without fully understanding the costs involved. So leasing it on an effective rent rate is one thing, but then the cost to split the floor, separate the services, then potentially give another contribution to make that space work for another tenant, when they are probably looking at spec fit-out space in the market or other sublease options. It's just not as simple as that.
With our clients, when we look at the broader picture, it's always about what is their core requirement moving forward, and then coming up with a strategy from there. And I think as a team nationally, that's what we look at.
I think flex spaces are certainly an option for many groups, particularly those who are really struggling to look longer term. So that's where the six-month, nine-month, 12-month commitment comes in. But we also find that that's typically a bit more expensive than potentially doing a 12-month renewal with your existing landlord. We have had a couple of clients since the pandemic hit, who have done 12-month extensions. We've also had some who have done a renewal on five years to maximize the incentive available. They're carrying a bit of excess space – probably about 20 to 30 percent – but their view is that they can use that space a bit differently, put a little bit of capex into it to rejig the fit-out a little bit, but then look to grow into that over the five-year term. And again, coming back to that having flexibility in the leas as well. So it gives them many options to think about. But I think it all comes back to the strategy or the core requirement before you go down one path or another.
Rebecca Kent
And is saving money in this environment always the desired outcome?
Dirk van Velden
Not necessarily. And again, I think what we've seen over the past 12 months is that everyone is looking at this in a different way. For some groups, certainly cost is at the forefront. And it's hard to ignore it when your office space may be sitting there and you're not utilising it. For those groups who are struggling to entice their staff to come back to the office cost is probably playing on their minds. But we've also got some clients who are looking at this as an opportunity to reduce their footprint and use it more efficiently, but actually building a new fit-out that is in line with their strategy of a new way of working. So I think it's going to be a mixed approach, including groups that are looking to reset the business with a new fit-out. So it's not just about cost savings. It's about what the business looks like longer term.
Jessica van Raay
Also a consideration for tenants subleasing is that they become a landlord themselves. So, are they prepared to deal with monthly rent collections, maintenance requests? It's important to feel comfortable that a sublease tenancy is an easy solution rather than that than a headache for the balance of the lease terms. There's a lot of weighing up. Is it just cost recovery, and can we deal with the administration that goes with subleasing? Because we can also look at lease surrender opportunities, so it's a clean exit and that is often preferred over the sublease. Typically, the tenants have to go and find the replacement tenant to introduce them to the landlord in that scenario.
Rebecca Kent
It must be a very good time to be a tenant representative, given the favourable market conditions for tenants. Are you finding that landlords are being willingly flexible?
Jessica van Raay
I'd say majority, yes. But it's case-by-case because we deal with a broad range of landlords, so you'll have commercial institutional landlords that are probably going to be more open into these sorts of discussions. When you're dealing with private high net-worth families, it can be a different story. They might have other motivations in terms of what they want to do with their family investments. They might not be quite there in terms of coming to the table on the lease negotiations.
Dirk van Velden
It also comes down to the vacancy exposure of that landlord. We might be dealing with a 500 square metre-tenant in a 30,000 square meter tower, the landlord's got 12,000 square meters of vacancy coming up in the next 12 to 18 months. So they're going to be doing whatever they can to retain their tenant pool. Valuation impact comes into play as well. We know that valuers are putting a longer letting-up period on any vacancy that comes back to the building. We're certainly seeing more flexibility on deals with institutional landlords. In Brisbane, some private landlords in the CBD will meet the market, but they certainly won't go beyond to try and secure a tenant. I think that just comes back to the mindset that it's their personal cashflow investment. They're not wedded to share price impacts or valuation impacts.
Rebecca Kent
Okay, so if I'm a tenant in the market and I’d like to change things up a bit, or make the most of what's going on, what at the very least can I expect to negotiate that might have been tricky, pre COVID?
Jessica van Raay
You’re asking us to give away all our secret special powers, Bec!
There are a handful of key items that tenants should be looking at. Front of mind to me is the lease flexibility part. Because we are in uncertain times, and seven to 10-year lease commitments are going to be pretty scarce these days when we've just got this hybrid working style and we’re trying to manage the space.
I think it's also ‘what can the landlord provide me in terms of third spaces, places where I can bring my team together to collaborate or do a town hall meeting? Or better wellbeing spaces to help entice my staff back to the office?’ That goes beyond just the end-of-trip-type shower and bike facilities. Landlords are creating more welcoming environments with better air quality, outdoor spaces and spaces to decompress. And then obviously, there are the key commercial items, like rent reviews that should be looked at and make-good obligations on the way out. They're all things that form part of the overall package.
Dirk van Velden
I think Jess has covered it pretty well. And we've got to be careful not to over-promise and under-deliver. But I think the flexibility is a key thing. It's certainly coming through a lot more frequently now in terms of the negotiations that we're seeing and the willingness from the landlord to give it to the occupier, depending on how much flexibility they need.
The other piece of advice is not to go into a negotiation thinking ‘that's what we're going to do’. I think what we've seen is people are willing to consider different scenarios. That's a good reflection because some landlords will negotiate in one way and others will push in another direction. In Brisbane some landlords are giving away bigger deals on three-year lease terms because they're banking on the market recovering by that stage. Others are looking for a longer lease-term, so they'll give away a bigger deal on that. So I think if our clients are looking to move – which they're not always going to do – they will look at fundamentally, ‘which is the best building for us? Which is the one we want?’ and then looking at the landlord's drivers to come up with the best strategy to get the best deal on that building.
Rebecca Kent
For tenants to get as close as possible to what might come in the short to medium term, presumably they should be thinking about the demographics of their workforce, where they're traveling from, the kind of amenities they’d like to be located close to, and the way they’d like to work?
Jessica van Raay
I think it's still pretty hard to predict, Bec, because if there's this hybrid model, as an employee I don't mind my train commute if I'm only doing it two or three days a week. Equally, I don't mind sitting in peak-hour traffic if I'm only doing it two or three days, I don't have that grind. Tenants are really still trying to capture all of those requirements. But public transport is still key, as is great road connectivity. But even something like smart parking - that's going to be another thing where the technology comes in to support the employee experience. That is, if I'm going to come in today, I want to be able to book a car space and I want to book my desk. I don't want to come in and find it's too hard for me. I may as well just work from home. As the worker, I’d like to leave at 3pm so I can pick up my kids from school. Or, if I’ve got other care responsibilities I’m only going to come into the office in the middle of the day. It’s all going to be very fluid, but hard to predict.
Dirk van Velden
I think the other topical conversation at the moment is the hub and spoke model and how it works within the work-from-home piece. My personal opinion is that the hub and spoke could work in Sydney and Melbourne. I don't think it's really there for Brisbane. This is because if you look at the geographical spread of our markets we've got our CBD, and all our core near-city markets: Fortitude Valley, South Brisbane and Milton, all pretty much right next to the CBD. So if you're going to go to those locations, you might as well come into the CBD if you're looking for a core location. There are groups that are choosing to be based in Fortitude Valley or South Brisbane, but I think the hub and spoke will be a bit of a challenge here in Brisbane.
Rebecca Kent
That’s JLL Jessica van Raay and Dirk van Velden there, who are representing office tenants at a time that is both really interesting for the huge changes happening in the way we work, and really exciting for the unprecedented office leasing deals being negotiated.
I’m Rebecca Kent, host of this JLL Perspectives podcast. If you like what you’re hearing, hit the follow, or subscribe button on whatever app you’re listening to me on right now, and you’ll get a ping when our next episode drops.
To get in contact with Dirk or Jess find this episode at www.jll.com.au/perspectives-podcast and you can drop them a line there. Catch you next time.
