A Paradigm in Transition: The Next Generation of Real Estate and Workplace

What will the next generation of real estate and workplace look like? Several industry leaders gathered recently to explore this question during a knowledge-sharing seminar. Over the course of the discussion, three major themes emerged: Evolution of the Space, New Way of Looking at Value and Opportunity, and Economic Impacts on Real Estate.

Framing our discussion, Bob Bach, Senior Vice President, Chief Economist at Grubb & Ellis, shared a number of statistics and ideas regarding the current economic situation as it relates to real estate. With 3.5 percent GDP projected for Q4 2009, Bach believes that the economy has turned the corner on the recession though perhaps a jobless recovery rivaling the recessions of 1991 and 2001 which took 14 and 29 months, respectively, before job growth returned to "norms."

Reported office vacancy is at 17.1 percent nationally. Bach projects that in the Chicago market alone (on top of 15 percent CBD and 24 percent suburban), an additional 5 percent in unreported “shadow vacancy,” where tenants have simply turned the lights out to minimize operating expenses. Noting that job creation is the No. 1 driver of office absorption, Bach went on to project vacancy peaking in the first half of 2011 and rents bottoming in the second half of 2011. It is this shadow vacancy which is obscuring total vacancy and may be a significant, overhanging number.

One glimmer of hope that Bach projected is continued low interest rates and low inflation. Though this supports recovery and job growth, continued reluctance in the capital markets to open purse strings is muting the recovery. With regard to real estate investment, he stated that with loans coming due and collateral value diminished by 35 percent to 40 percent from 2007 peaks, properties are technically in default. Banks are doing "pretend and extend" with the expectation that it may take three to four years to work through this over capacity, though with little real appreciation. All this said, the net impact to tenants is that, though they may be in the driver seat for great deals on new leases, they need a credit report on their landlord’s financial health to determine whether the tenant improvement dollars will actually be there when it comes time to pay out and a Ouija board to predict who will be signing that check.

What does this mean for the workplace? There will be a premium on flexibility, a proliferation of short-term lease extensions, and companies showing less of an inclination to own space. While the predictions aren’t the most positive, there is certainly opportunity for reshuffling the deck and creating innovative solutions. What follows are some of the key ideas.

Evolution of the Space

The economic downturn created the perfect storm for a mobile workspace to really gain traction. As Carolyn Austin-Diggs, Deputy Associate Administrator of the Office of Real Property Management, Office of Governmentwide Policy for the General Services Administration, shares, "even before the downturn, the GSA was behind this initiative. Telework not only reduces the need for space, but is also an energy efficient measure, reduces commuting time and cost, reduces emissions from commuting, and attracts a more tech-savvy and mobile employee."

One challenge, however, is with implementation. Austin-Diggs says that it begins with updated HR and IT policies, and even the appointment of a Chief Telework Officer. It also requires building upon infrastructure by automating the analysis, continually tracking efforts, using an online university system, and furthering the expanded use of telework centers located in metropolitan areas.

What does this mean for how the workspace is designed? It must go beyond just a place for touching down and meetings to mirroring hospitality space in terms of how people come together. The future value of workplace will increasingly be communication between workers which will mandate looking at new ways of supporting interaction.

Cost reduction remains centerstage. Sam Unger, Area Director of Real Estate for Ernst & Young, reflects that for Ernst & Young, and he’d propose most CFOs of major organizations, ” a reduction of cost of real estate is like a drug. It will be very hard for CFOs to kick the habit of attractive reductions in their overall costs.”

Furthermore, Chris Hood, Program Manager of the HP Workplace at Hewlett Packard, suggests that it is not the recent downturn that has driven HP to rethink their space portfolio and argues the rationale is global competition and environment. Factors influencing it are employee mobility which is not something that HP drove, it just happened as a result of enabling technology and forward-looking attitudes to managing work people and performance. He points out that companies need to be bold about the transition to the mobile workplace. “If you’re trying to make 10 percent or 20 percent improvement in space, it doesn’t work. You can’t get rid of enough space to be able to afford the investment in the space that’s left behind. But if you get really bold—reduction in the 50 percent and above realm—suddenly new horizons open up and you get some sense f both the cost savings and also the sense that more people in a smaller space are like a good party: the interaction increases and the energy level rises.

Hood says HP is pursuing “less space, but better space.” Increased utilization by leveraging mobility in its many forms is key to their success. The goal for HP is to aim for a 90 percent target. Unger adds that Ernst & Young has a utilization rate goal of 75 to 80 percent. “Imagine that you walk around 100 workstations and at any given moment 80 to 90 of them are in use. That’s something we weren’t able to say in the past,” says Hood.

The net results for HP have been nothing short of amazing. A project example demonstrated space savings in excess of 60 percent and energy cost savings close to 50 percent. HP is also taking a number of other strategic steps to drive further competitiveness. It is integrating FM into the hands of a very limited number of outsourced service providers, looking closely at where they locate businesses for factors of cost, talent and infrastructure, rationalizing support activities such as training, labs and contact centers into fewer strategic locations and recognizing that such change requires careful management. Their philosophy is to place change management, not in the hands of outside consultants, but where it will be most effectively delivered, with their managers.

New Way of Looking at Value and Opportunity

Through a positive lens, setbacks can be viewed as opportunities—a notion which is especially true for commercial real estate and the workplace. David Roberts, Managing Director of Project and Development Services at Jones Lang LaSalle Americas asks us to consider that while volume is down significantly in traditional areas, opportunities have arisen in others. “Like all RE professionals, project managers have had to find ways to innovate, add value, and create opportunities,” he says.

One such area is value recovery. Roberts points out the proliferation of unfinished projects nationwide. “Basically, the builders have dropped their tools and walked off the site,” he says. In turn, to monetize their RE value banks require support to complete their inherited, half finished assets. “It’s an opportunity highlighted by the economy and an example of how the downturn can ignite new product offerings.

Integrated delivery is also proving to be an opportunity. Mabel Casey, Vice President of Global Marketing for Haworth, observes that clients are looking at the big picture. “Our clients come to us with [a range of] issues—capital cost problems, life cycle costs, workload forecasting, portfolio optimization, speed to market, total cost of occupancy. From a project management perspective, we spend a lot of time alongside brokers, consultants, and energy managers looking at a total solution for that client as opposed to just a project.”

Roberts concurs on the value of integrated delivery. In addition there are other opportunities— consolidation of offices, reducing real estate portfolios and projects involving renewal and repositioning of existing assets are routine but accelerating in this economy. Projects that reduce energy consumption are also proliferating. He notes that some of his clients are realizing a 2-3 year payback on capital upgrades. Simultaneously, the owners/ investors differentiate their asset and enhance building value as their property becomes ‘smarter’ and more energy efficient. A recent CoreNet Global survey revealed 74 percent of respondents are willing to invest in energy reduction. This area may lack “sizzle” but the potential returns warrant a thorough opportunity analysis.

Economic Impacts on Real Estate

Lisa Konieczka Executive Vice President at CB Richard Ellisoffers insight from the client’s perspective. "It’s about risk management. How do you react to the economic pressures not only within your overall business, but within the real estate components that have impact on your overall business plan, and how do you mitigate risk? There are the obvious ones: shedding surplus space, minimizing capital investment. It’s the same way for landlords as it is for tenants because they want to take that capital for business," she says. In addition, "People are making short-term commitments and trying to defer decisions until they are in a less-risky place to make that decision, but at times, there are also the opportunistic folks thinking ‘gosh, how can I time the market perfectly to get the very best deal out there?’"

An alternative is subleasing; but in the current market subleasing space can be very expensive. Konieczka notes “[subleasing] has been the biggest challenge for 2009 for most tenants out there. The economic relief is delayed because you’re subleasing space at a discount, you have to pay for TI for demising costs, for commissions and rent abatement, which means you get no economic relief for a very long period of time.”

Bottom line is what are our clients facing? What are landlords facing? What are the pressures on tenants? Konieczka suggests that there is a disconnect between tenant expectations and a landlord’s ability to deal. “The overlying impact we are seeing from the user perspective is that capital markets are driving so much of the decision-making process—a departure from previous soft market cycles.” Landlords are viewing replacement of attrition as the new growth. In this market “self help, offset rights escrow accounts if not letters of credit [are] a complete departure from what we’ve seen, where it’s always been about tenants.”

Konieczka concludes that “ultimately, cash is king and monetizing owned assets as part of an exit strategy program is something that tenants are starting to contemplate. The return of the capital markets will make that monetization process become cost effective and productive.”

In conclusion, one significant unknown is the impact of shadow space on real estate economics. Most participants agreed that in the near future, this space will only increase, and that corporations are willing to make it dark just to take it off the books. Though we can attribute part of this manifestation to the economic changes and global competition, the evolution of the workplace, driven by technology and mobility, will propel a paradigm shift in the way in which we evaluate, acquire, utilize and dispose of real estate.

The Webinar in its entirety is available as a Window Media compatible download at: http://www.interiorarchitects.com/knowledgeshare/2010/NextGenRE

About the Authors

R. J. Brennan is Associate, Director of Workplace Strategies at IA Interior Architects, Chicago, Ill.