New Rules for Office Tenants

Two months into the coronavirus crisis, San Fernando Valley area office specialists see landlord and tenant clients alike struggling to stay solvent. And commercial real estate brokers believe the local office market will look quite different on the other side of the pandemic. Tina LaMonica of NAI Capital’s Pasadena office at 225 S. Lake Ave. specializes in the Tri-Cities market on the tenant representation side. “Office leasing stopped the day the stay-at-home order was in effect,” LaMonica said. “All deals were either canceled or postponed indefinitely.” Her NAI Capital colleague, Senior Vice President Adam Comora at the firm’s Encino office, said 65 percent of deals in the pipeline have been put on hold or canceled. Sheryl Mazirow, head of Westlake Village-based brokerage Mazirow Commercial, represents tenants such as attorneys, accountants and insurance companies. “I have a number of clients that have been challenged,” Mazirow told the Business Journal. “Landlords (tell their tenants), ‘OK, please provide me with a narrative.’ It has to be very substantiated. It’s a contractual obligation.” For her clients seeking rent reductions or deferrals, “it has been very difficult to get any rent relief,” LaMonica said. “Institutional buildings have loans on the property and have debt – most of the answers have been ‘No!’” “I’ve seen some office clients who have been successful to get some sort of relief – a percentage deferred or abated, but they will have to repay it at a later date,” LaMonica said. “There will be a tremendous amount of pressure on the landlords, the rates will have to go down, but we have not seen anyone reducing their rates (yet).” If a tenant has two years left on a lease, it can be a win-win situation for landlord and tenant alike to renegotiate it, according to Mazirow. “We’re working a great deal with our clients in restructuring and extending their leases,” Mazirow said. Comora, who represents institutional property owners, said that it is unfair to view tenants as the only victims of this economic fallout. Landlords are also feeling the pain, caught up dealing with tenant requests. Many are setting up reviews on a case-by-case basis. “If they’re not going to get relief, the landlords are going to lose the building to the bank. I don’t think that banks will want to be landlords themselves,” Comora said. Market correction Bill Boyd, head of Kidder Mathews’ Tri-Cities office, said there actually is an upside to the crisis in the monumental course correction of long-dysfunctional market values of office buildings. “A forest fire is good for a forest once in a while; if it took a pandemic to tip the scale, so be it,” he said. In the last four quarters, office rental rates have inched up, but vacancy has also gone up, said LaMonica. “There’s not really any correlation,” she noted. “They were buying and trading buildings on assumptions of square footage going up – they’re not going to meet these assumptions now with this pandemic.” In the Tri-Cities, the vacancy numbers will continue climbing, LaMonica said, citing CoStar Group statistics. “It jumped from 16.2 to 17.1 percent vacancy from Q4 2019 to Q1 2020. I anticipate that number going up because of the economic uncertainty resulting in many tenants downsizing or closing their offices,” said LaMonica, based on what she is seeing in the marketplace talking to tenants and industry professionals. Meanwhile, subleases jumped from 148,000 square feet in Q4 2019 to 218,000 square feet in Q1 2020. Typically, leases run three to five years, and companies have already been putting their space on the market for sublease. LaMonica said the volume of subleases in the Burbank and Glendale submarkets increased from 45,000 to 78,000 square feet from Q4 2019 to Q1 2020. Boyd said good luck trying to fill those vacant offices. “Just because space becomes available doesn’t mean there’s demand,” he said. Big picture Boyd has seen market dips, but he has never witnessed anything as dramatic as the bottom dropping out in March. “Previous recessions have never had the dramatic cultural impact across all industries; this may even tip into a legitimate depression,” Boyd said. “It will be as bad an experience as I’ve seen. … We use the term ‘nuclear winter’ to portray what the next 12 months will be.” Added NAI’s Comora: “It might take us a little while (for business to rebound). It’s an unprecedent period. We’ve had two months-plus where everything came to a halt.” What makes this scenario different than 9/11 or the Great Recession, Boyd noted, is how all-encompassing the virus crisis is compared to previous economic slumps. “Let’s take Walt Disney Co. as an example – one of the most revered and respected firms that we have,” Boyd said. “If the movie revenue was off, at least theme parks could offset it. If theme parks were off, Disney had ad revenues from ESPN. … It’s just startling how all of those lines are affected. You have movie releases delayed, ad revenue at ESPN down, theme parks (generating) zero (revenue).” That said, Boyd predicted that major players such as Disney will recover. LaMonica agreed: “Large firms such as Disney and Warner Bros. will survive but they will probably downsize.” However, she wonders about the ecology of smaller entertainment companies in Burbank, Glendale and North Hollywood dependent on the studios. One of LaMonica’s clients, Lumma, a NoHo-based motion picture effects company originating from Argentina, has been hit hard by the pandemic. “I put them in the building last year,” she said of their 4605 Lankershim Blvd. address. “They built out a full soundstage in their space to demo the chairs for theaters.” Coworking One question mark hanging over the office sector post-pandemic will be collaborative spaces, especially if restrictions on the number of people able to work closely remain in effect. Mazirow has already seen diagrams of coworking space reconfigurations — to include social distancing, higher cubicles — and while the format was hot pre-pandemic, she believes that the pendulum has already swung hard in the other direction. “Coworking is just the reinvention of the old Barrister executive suite with some more bells and whistles,” Mazirow said. “Those days are over. … The coworking model is not going to survive.” Other brokers agree that the coworking trend has peaked. “Most believe that the market got over-extended in the amount of coworking space and the amount of the companies offering such space,” Boyd said. Alluding to the 2019 internal problems of coworking leader WeWork, Boyd said, “It was never understood how some of those companies could lose such significant amounts of money and portray such a successful model.” According to reports, the New York-based coworking company lost $1.61 billion in 2018. In November, the Wall Street Journal reported that WeWork stood to lose more than $3 billion in 2019. WeWork is currently advertising more than 1 million square feet of available space to office brokers in Southern California. In an email obtained by CoStar News, the New York City firm — which just debuted a new location in Woodland Hills at 21255 Burbank Blvd. in March — listed space at 33 locations in greater Los Angeles and Orange County, amounting to availability in roughly 80 percent of the firm’s 41 locations in the region. Coworking office space requires tenant improvements, and “landlords are not going to pay for it if there are no tenants,” Mazirow said. “The tenants are going to want smaller footprints.” The fallout will be lower occupancy costs for tenants, lower rents and more concessions from landlords, she said. Comora at NAI Capital believes the format is salvageable with some losses. “WeWork-types of operations are probably going to sink, but others are set up better. They don’t have the debt, their layouts are different, it’s not as much coworking as it is executive spaces,” he said. Post-pandemic After the pandemic, LaMonica expects some tenants to downsize while others will completely vanish. For example, she knows of one transportation leasing company that just opted not to renew its lease. “The future of office space is going to be much different from what it is today,” LaMonica said. “A certain number of people work from home. Their current footprint will not accommodate the new social distancing requirements. They will not be expanding their footprint to accommodate it.” “There’s certainly been a movement where companies are reducing their footprints,” Mazirow said. “That is not a new concept of it but it’s completely different now.” There are already signs that this is happening with large-scale companies. On May 4, CoStar announced that insurer and financial services provider Nationwide will permanently transition to a work-from-home model for five of its U.S. offices, giving up more than 640,000 square feet in the process. The company will continue maintaining traditional offices at four main corporate campuses, including its national headquarters in Columbus, Ohio. Boyd observed how, in the past, firms “right-sized” for efficiency: attorneys, for example, shedded obsolete law libraries. However, certain businesses will have a harder time cutting back on space, as they need a considerable on-site staff. “We are social by nature and our productivity merits collaboration. There’s real synergy in office collaboration,” he said. While Comora foresees companies shrinking their footprint, he does not see working from home replacing the office format. “You’re lacking a lot of the collaborative synergy and the focus (when employees work from home),” Comora said. “If you’re a salaried employee, it’s hard for your bosses and the company to keep you accountable.”