Kidder Mathews Analysis: Thriving in Down Markets — A Playbook for 2023

Posted In — Market Research | Trend Article

Maximizing space for occupiers has become a thorny proposition in 2023 as the market continues to emerge from a nearly three-year-long pandemic period. Companies are confronted with the complex challenge of knowing when and how to bring employees back to the office — and how much space is needed now.

Across property types, strategies vary. However, one thing is certain: change is underway. As some businesses contract, others are looking to grow. Today’s market presents opportunities for companies to move to a higher quality building or upshift to a better market.

“Wherever there is change, there is opportunity,” says Kidder Mathews CEO Bill Frame, SIOR, CCIM. “In the past year, we’ve added over 100 sales professionals in our three divisions of brokerage, valuation, and asset services, as well as continuing to invest in our people, technology, branding, marketing, and R&D. We have achieved all this while continuing to offer 90/10 commissions to our brokers, industry-leading splits to our appraisers, and competitive salaries to our property managers and corporate employees. We are profitable, and as such, our stock value continues to increase, and we continue to pay dividends. While many of our competitors are cutting back and laying off, we are doing the exact opposite. This has been a very opportunistic and exciting time for us in terms of growth and solidifying our infrastructure.”

Commercial real estate experts at Kidder Mathews look at the myriad of considerations facing occupiers and provide a playbook for the year ahead.

Space Management

There are several ways companies can manage their space to maximize its use while still capturing advantages in a tenants’ market. Kidder Mathews’ Matt McLennan, SIOR, CCIM, an EVP in the Greater Seattle market says, “Sublease space available is at an all-time high but general market vacancy remains low, so when handled appropriately, tenants often stand to benefit from offering the broad market a better-than-market deal.”

Tenants considering relocating or adding new space are wise to look at ways to reduce square footage and occupancy costs. To that end, Kidder Mathews’ Paul Picciani, an SVP in San Francisco, says companies can make the office experience more attractive to employees by improving the space and, in some cases, relocating to decrease the commute. He advises tenants to start the process early, at least two years prior to lease expiration. “That includes meeting with their broker and architect, along with gathering employee input on what would make the next space as attractive and interesting as possible to work from,” he says.

McLennan adds, “We have seen a flight to quality for some time now. As the logistics industry continues to innovate and improve, tenants are learning to be more efficient in their use of space. Newer Class A quality product provides more efficiencies, and although it comes at a cost, most tenants can budget for it.”

Businesses that are expanding have a chance to capture space that’s unneeded by companies that are downsizing. There will likely be some enticing opportunities to graduate into Class A buildings in the best location. To be sure, given the rise of remote work (and reluctance to give it up), companies with large office footprints are likely to downsize. Buildings in markets where people prefer not to live and work may need to get creative to attract new tenants or re-envision an asset. For example, if a building previously catered to technology tenants and those companies are moving to other markets, the landlord may be wise to cater to a new or more diverse demographic.

That was just what Jamison Properties, the largest property owner in Los Angeles’ Koreatown, did. The company has slowly been converting underperforming office product to residential market-rate housing. The net result of this strategy is office space supply has been reduced significantly and demand has been increased, which works to drive office rents upward. This not only impacts the struggling property, but the submarket overall.

Kidder Mathews’ Christopher Steck, CCIM, an SVP in LA, says that “similar goals could be achieved on a smaller scale at other assets. In addition to residential conversions, other secondary uses such as hospitality would be ideal targets to increase a building’s overall occupancy.”

Space Efficiency

Whether the strategy to maximize space efficiency involves a relocation, expansion, upgrade, contraction, or sublease, the first call for a company should be to a local broker to get educated on current market conditions and availability. “It’s also very important to define the requirement early in order to maximize the efficiency of the search and ability to take advantage of the right opportunity when it presents itself,” says McLennan.

The advice for tenants with excess space now is to be prepared to give it up at a significant discount. “Competition for direct and sublease spaces is getting greater and greater, so those owners of space that are getting deals done are the ones that are willing to be most aggressive,” says Steck.

Since the pandemic started in early 2020, the office market has steadily softened. Many of the companies that adopted a permanent or hybrid work-from-home policy simply do not need the amount of office space that they once did. For example, in March 2023, greater LA’s office vacancy stood at 15%, which is the highest it has been since the early 1990s, according to Costar. Downtown LA’s numbers are even worse, with a vacancy rate of 26.71% today, up from 25% in 2022, and a 10-year average of 19.43%. These numbers don’t include the nearly 1.6 million square feet of sublease space on the market.

Steck says, “As a result of the deteriorating fundamentals we are seeing in the market, many of downtown LA’s key players are looking to divest from the market. With more and more office space available for lease and fewer tenants competing for them, office investors have become increasingly bearish on DTLA.”

Sublease Strategies

Companies that elect to pursue a sublease strategy for their existing space are discovering the availabilities are growing. There is still much to be determined about return-to-work plans, and this option is becoming rather limited.

Picciani points out that subleases tend to fall into one of two categories in today’s market.

“If a company has less than two years left on a lease, they must accept the fact that they won’t be able to sublease because there’s simply not enough term left — in which case they will need to just make the best of it,” he says. Another option for a company in this short-term category would be to put the space on the sublease market ASAP with a creative and aggressive approach that a broker helps craft and execute with them based on the market. A final option for deals with under two years remaining is to negotiate to return the larger suite to the landlord while leasing a smaller suite in the building.

Companies that have more than two years left on a lease do have the option to put it on the sublease market quickly with a creative and aggressive broker-led approach. Another option would be to consider partnering with a synergistic company to share the space.

Steck notes that tenants considering relocating or upgrading to new space are likely to find that Class A office space has been hit particularly hard and can be obtained at hefty discounts. Most tenants are also downsizing, so the upgrade in space, given the discount and reduced footprint, has minimal impact on the bottom line.

McLennan added, “Tenants who are looking to ‘future proof’ and plan out their space decisions efficiently should be looking much beyond the typical five-year horizon.” Historically, most tenants enter a lease on a five-year basis assuming that after four years they will re-assess and make new plans accordingly. Given the costs associated with space use such as moving expenses, equipment purchases, and labor, the cost to move can be significant. And even if the cost to move isn’t significant, the time invested in assessing the situation every three to five years can be.

“While I’m not suggesting that you should go lease every space with a 15-year term, tenants should be looking at the space and what utility they expect it to provide over the next 10 to 15 or more years. Most notably, does the current footprint provide the ability to grow the business if needed, given that (most) tenants and business owners probably prefer and plan to continually improve their business over time,” says McLennan

Future Strategies

Landlords are still trying to figure out exactly how to adjust their lease strategies with tenants, who don’t yet know how much space they will require. That is clearly creating some distress in the office sector. There have already been a few buildings that lenders have taken back or have gone into receivership. Some lenders will work with owners to find solutions — whether that involves restructuring a loan, writing down a loan, or contributing more equity — rather than foreclosing.

Future occupancy strategies are expected to include shorter-term deals that offer flexibility. Steck believes that is likely going to be the norm moving forward.

The best occupancy strategies in the future will vary by company, market, and industry sector “No one size fits all,” says Picciani. “The purpose of office space is to gather employees in one place so they can do their best work to advance the company’s interests. If a company has found through the pandemic that their employees can and are doing their best work from home, then perhaps an all-virtual structure makes the most sense going forward.”

Conversely, if that’s not the case, Picciani recommends building maximum flexibility into the lease — which could include shorter terms, more subleasing flexibility, expansion options, etc. Those considerations should be part of the strategy, along with getting feedback from management and employees about space design and location. “Regardless, this will be a time-intensive process, and no matter how hard you try, no one has a crystal ball,” Picciani says.

For more information or to speak with one of our experts, please get in touch.


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