In this article, you’ll discover:

• The office market is evolving, not collapsing, with a focus on high-quality spaces.
• Converting outdated office buildings to housing is complex and costly.
• Tenant protections are crucial due to potential landlord defaults.

The outlook for the nation’s post-pandemic office market is stirring considerable anticipation, as stakeholders eagerly monitor developments to ascertain whether a looming bailout scenario is on the horizon.

Amidst the uncertainty, this article serves as a debunking guide, dispelling prevalent myths about the office market’s fate. By peeling back the layers of misconceptions, we aim to reveal the adaptability and resilience that define the commercial real estate sector, and highlight the moves that savvy tenants should make.

In an era of unprecedented change, the office market isn’t disappearing; it’s evolving, shaping itself to meet the evolving needs of a dynamic workforce. And it’s time for corporate tenants to get on top of the shift. So, join us as we explore the realities behind the headlines and uncover the promising transformations taking place within the realm of commercial office spaces.

1. The Office Market is Doomed

Yes, there has been unprecedented volatility, but most of the pain has been isolated to specific property conditions. There is not a total Office Apocalypse, it’s more like an office evolution. Buildings with outdated features are dying out, marked by low demand. Property owners can either adapt to the priorities of the new leasing environment or face default.

On the other hand, properties that do have the key features modern tenants want are surviving.

Take for instance the MetLife Building in Midtown Manhattan. The 3.1 million-square-foot office and retail property was 99% leased as of mid-August of 2023. This comes as the Manhattan office vacancy rate is under-performing in stark contrast with a 22.7% overall vacancy rate.

So how does the tower stay fully leased in the midst of a dismal office environment? How about the following points:

• It has premium features
• It’s been renovated multiple times
• It’s LEED certified
• There’s been investments in employee experience through:
• Creating fitness and wellness centers
• Installing easy access to the lobby through commuter hubs
• Improving the aesthetics of the lobby

This property is coming out of Manhattan’s Office Apocalypse unscathed because it is the poster child of the flight-to-quality. Since the pandemic, the option for corporate space usage forced tenants to scrutinize whether they were getting the most out of their commercial real estate investments.

This has driven a mass-exodus from undesirable property types. Instead, many companies downsized according to hybrid-work accommodation, stopped paying for unused space, and invested into streamlined, premium features.

This is evident through the climbing rent growth among Manhattan’s top tier office space as average rents for lower property classes decline.

In fact, any recovery the post-pandemic office market in Manhattan has shown seems to be primarily driven by an ongoing shift towards high-quality properties.

An overwhelming 81.6 percent of tours in New York City involved Trophy and Class A office space in February 2023. This number reveals how quickly and persistently interest in these types of buildings climbs year-over year. In February of 2022, 76 percent of tours were for premium properties.

Interest in office space is dominated by higher class buildings. So, the office market isn’t dying, it’s adapting. And the properties that are surviving the shift prioritize user-experience, technology, and sustainability.

2. All the Extra Office Space Can Just Be Converted

We discussed the Flight to Quality, but how does it affect the owners of outdated buildings who can’t afford financing mass-renovations?

Class B property types (or under) are being urged to hand back the keys because they have a long battle ahead. But that doesn’t necessarily solve the wasted space problem. Hundreds of thousands of square feet sitting empty in prime locations is causing a major drain on an area’s financial health. And now, it’s not uncommon to hear that converting old offices into housing should be the solution. Well, not so fast.

Converting empty offices to housing is a slow, complicated, and expensive process. And, in reality, the number of buildings that could qualify for conversions are too few to have a widespread positive effect.

While repurposing an office is usually a quicker solution than building a functioning structure from the ground-up, it is not simple, nor cheap.

Beyond taking an initial loss in the amount of rentable square feet, the property owner faces a devaluation of rent per square feet, a pretty hefty one.

And if they can stomach that, they can then consider the immense cost of construction. Consider the sheer amount of work required to gut office buildings, their plumbing systems, and layouts.

Oh, and this is only of your property is properly zoned to become residential. Zoning and other regulations have been massive hurdles to developers so far. In fact, the cities with the most conversions have all made their zoning regulations less complicated to encourage more interest.

The high cost (and massive undertaking) of transforming offices to apartments is not yet worth it to most property owners. It’s predicted that the value of offices will need to further drop before mass conversations are commonplace.

Because of this, the conversion pipeline will probably be dominated by luxury buildings which can charge higher amounts per square foot, thus providing a more appealing ROI. So even though affordable housing is what is called for in many cities (and makes a good political soundbite), it will not necessarily be common because right now as it’s not a strong enough investment.

Because beyond expensive, it’s complicated: Read more about the Conversion Process.

3. If Landlords Default, Tenants Won’t Experience Any Disruption

This is not true, unless you outlined safeguards in your original lease. Unfortunately, with mass-landlord defaults on the horizon as the next wave of CMBS loans are due, it may be too late for many existing tenants.

We hate to mention it, but the likelihood of stress following a landlord default is even stronger if you used the landlord’s broker to write your lease. Your landlord’s broker has the fiducial duty to get them the best deal, and unfortunately this can come at your expense. They likely didn’t push for tenant self-help rights in the lease.

Self-help rights enable tenants to recover potential financial losses from a drop in services related to a landlord’s default. This includes the right of offset which enforces the landlord to reimburse any out-of-pocket expenses the tenant makes.

Beyond this method, tenants drafting new leases can also recover finances related to their tenant improvement allowance. Before a landlord defaults, putting the tenant improvement allowance in an escrow account protects it, ensuring the tenant isn’t responsible for any CapEx improvements to the property.

In addition, don’t sign any new leases without the inclusion of an SNDA. This is a true tenant weapon in the new leasing environment. This clause guarantees your right as a tenant to the leased premises in case of landlord default or foreclosure. The SNDA allows the tenant to keep occupying the property according to the existing lease terms, even if the landlord loses ownership. 

It’s definitely a minefield out there. But, by doing your due diligence, you can optimize your CRE portfolio like never before and avoid the disasters before they happen. And by working with a True Tenant Rep™ at iOptimize Realty®, you never have to worry about signing a lease that doesn’t have your best interests in mind. By only working for tenants, True Tenant Reps™ ensure that you are protected in your leases.  

Takeaways for Office Tenants

So, there’s a lot of myths surrounding the future of office space. But what is true right now that the right tenant looking for the right space can make the deal of a lifetime.

Taking advantage of the current situation, tenants can negotiate harder deals and secure more favorable lease terms, benefiting from concessions offered by landlords. Alternatively, they can explore the increasingly flexible leasing sector, allowing them to find a space that perfectly aligns with their square footage requirements. But only if you know what you’re looking for. Learn how to find the best office space for the best price and terms on the market in the free course below.