With the arrival of 2018, many architects and developers of Class A office buildings are wondering how they can simultaneously maximize space and increase productivity. The most popular solution that has emerged over the past few years does not involve building side-by-side cubicles or cramming more workstations into floor plans, but creating open-concept space. However, creating an open-concept office comes at a price. DBRS, Inc. (DBRS) has observed that the cost of attracting and retaining tenants has increased because of changes to how space is currently being used in various markets. With today’s average outstanding amount of securitized office loans standing at $123.4 billion, representing just over 20.0% of total loans in the securitization market, it is important to keep in mind the costs that landlords incur to keep their properties competitive. This commentary examines the shift to open-concept space and some of the drivers behind the costs.
Ted Moudis Associates Inc.’s (TMA) 2017 Workplace Report presented some key findings about the layout of the modern workspace. The biggest one is that Class A office spaces are shifting to open workspaces from enclosed workspaces in significant numbers. This means that large corporate offices are trading their closed-off cubicle spaces and hallways lined with enclosed offices for a mix of low-walled desks; benching systems (i.e., conjoined desks without walls); and common seating areas, including low-slung office couches or chairs, in order to foster the exchange of ideas within and among teams. Another emerging dynamic office layout is known as hoteling, wherein employees sign out their own workspace for the day from a choice of unassigned seating. This enables employees to choose a different workspace every day of the week provided that another employee has not already checked it out. The objective behind moves like these is to create a more collaborative and friendly environment that promotes productivity and familiarity among employees.
TMA’s research shows that open-concept workspaces reigned supreme in 2017, with a staggering 91.0% of surveyed workplaces implementing such layouts into their floorplans (see Exhibit 1).
According to the 2017 Workplace Report, other emerging trends seen in offices include the creation of paper-light offices in the form of less filing-cabinet space; alternative space, which refers to meeting space (for teamwork), focus areas (isolated areas free of distraction) and amenity areas (casual workspaces, such as cafe seating for informal team meetings); and shared amenities, such as fitness rooms and pantries.
Exhibit 2 outlines the kinds of popular seating arrangements that companies are implementing in their renovation plans. Increasingly, in most floorplan arrangements across all industries, there is an almost 50–50 split between workspace and alternative seating space. In 2018, the report predicts that there will be an increased focus on seating areas and activity-based work and amenity spaces as well as a decrease in the amount of paper usage around the office.
The General Property Manager for the global real estate firm Hines, Jennifer Murphy, states that “[Hines] noticed [the change to communal offices] starting in the 2010s during the recession years. It was a more attractive option for firms looking for a lower cost.” Murphy cites the Chicago-based 333 Wacker Drive property she manages as an example: The majority of offices in that building prefer a communal design. According to Murphy, “That’s where the market has gone and is continuing to go.”
DBRS analysts have noticed the same preference for communal design by office properties, such as the Microsoft Corporation–owned 222 Second Street building in San Francisco and the Middleton Partners, LLC–owned 411 East Wisconsin Center in Milwaukee, Wisconsin. These buildings are often owned by institutional investors that have an expansive renovation budget and are trying different methods to attract and retain top tenants while maximizing productivity in the face of an ever-changing workforce. Some of the most common building amenities DBRS observed include high-end cafeterias and pantry areas, fully stocked fitness centers, conference facilities, parking and valet spaces for both cars and bikes, and other bonus rooms like film-screening areas. Along with these high-end building amenities comes a hefty price tag for building owners, including both the initial cost of implementation and the increasingly higher ongoing operating expenses necessary to maintain the amenities, a portion of which often gets passed through to the tenants via increased common-area expense reimbursements.
As for individual tenant build-outs, DBRS has observed a steady rise in landlord-offered tenant improvement (TI) packages over the past five to ten years. Today, it is not uncommon to see TI packages range from a low of $20.00 per square foot (psf ) to $25.00 psf up to well above $50.00 psf, for which generally a large majority is related to alternative work areas and unique build-outs that are becoming increasingly necessary with open workspaces. As shown in the table below, in major office markets, money allocated to TIs by landlords for new leases has increased by, on average, 97.0%. DBRS notes that although some of this expense may be partially offset by higher net rental rates, it is still a significant increase from ten years ago.
Despite this trend, wherein larger individual workspaces are swapped out for smaller individual workspaces with more common areas and alternative workspaces, the overall average office square footage per employee is still shrinking. According to CoreNet Global, the average square footage per employee has dropped by approximately 25 square feet (sf ) over the past five years to 151 sf in 2017, though this can vary substantially based on the type of tenant. Murphy states that the layout of space depends on the tenant’s industry, with creative and information technology industries preferring alternative spaces and more traditional types of businesses preferring the standard cubicle/office layout.
As far as office walls go, the vintage era of the 1940s up to the 1960s had open-concept office space like today, but desks were generally detached and workspace included little or no general meeting areas. In fact, the older floorplan was more chaotic, with designers trying to push as many workers into an office as possible. In the 1980s, offices fully embraced cubicle culture, with tall walls surrounding desk spaces, especially for more conservative industries and businesses. This formal workstation layout continued into the early 2000s until strong technological evolutions (such as the mobile phone) made it unnecessary to be at the desk all day. From there, open-concept office space has been increasingly encouraged by employers and office designers alike.
According to iQ Office Suites, a company providing co-working-space rental solutions, offices can benefit from being open-concept workplaces with shared resources to limit energy usage and foster a more collaborative environment. Employees can also enjoy the general benefits of wellness rooms (i.e., rooms set aside from regular work areas for employees to de-stress), fitness rooms and other common amenities that make the working area less cold and clinical and more inviting with a neighborhood feel. Given the rapid shift in tenant/employee workspace preferences, investors should prepare themselves for substantial re-leasing costs in buildings with more outdated layouts/finishes, with loan structures ideally incorporating these higher costs. When determining TI costs in its net cash flow (NCF) analysis, DBRS primarily focuses on actual costs incurred on recent leasing, which often reflect more modern build-outs and can result in a high variance from the issuer’s NCF. DBRS will go into more detail on TI costs for office buildings in a future research piece.
This piece is available on the DBRS Viewpoint blog and on the DBRS website.
Follow Stephanie Hughes on Twitter @StephHughes95.