Creative Office Alternatives to Deal with Large Vacant Spaces

Across the country office building landlords have seen average office space deals become smaller and smaller. For instance, the average transaction in San Francisco today is 2,800 square feet. During the year 2000, the average transaction was 7,000 square feet. In Santa Clara, the average transaction in that same year was 10,000 square feet and today it is less than 3,000 square feet.

Vacancies in most major cities are in the high teens and low twenties. However, smaller suites, under 5,000 square feet have vacancies in some of the same markets as low as 5%. San Francisco currently has a 6.5% vacancy on the less than 5,000 square feet suites.

With most of the surplus office space found in larger space, it seems logical that landlords will begin the process of dividing these spaces to meet the demands of smaller tenants. Unfortunately, that is not an alternative for most landlords until prices also increase dramatically.

At rents just above breakeven for most Class A and B product across the country, the cost to divide spaces can be extremely expensive. Corridors, additional bathroom facilities and code compliance costs related to life safety are all just part of the major costs associated with dividing spaces into smaller suites. Unfortunately, there is no prediction from any expert in commercial real estate that rental rates will increase anytime soon. Therefore, how does a landlord rent their existing larger spaces in this kind of environment? They must think “outside of the box.”

Back in the 1980’s during the last office market collapse, building owners were successful in leasing larger spaces by offering a number of creative ways to have smaller tenants lease these larger spaces. One approach was they created the “pay and you grow” program. A tenant was offered a larger space that had an imaginary demising line. The tenant only paid rent on the space they used. As they grew and they crossed the imaginary line they were charged for the additional space they used.

This offered the tenant more flexibility in handling growth than optioning existing space. It allowed them to use space when needed, not when an option date had to be exercised and also to use the exact amount of space they needed, not the uncertain amount of growth space that they may have locked up with an option.

Another approach the landlords used was moving tenants into larger spaces at reduced rents with the right to move them to smaller spaces in the future at the same rates if they found a larger tenant. This gives the tenant a reduced rental rate now that gets locked into the exact square footage that the tenant may need later. The landlord wins because he gets flexibility and rent now. If a larger tenant is secured, even though he has locked in lower rents to the smaller tenant, he still makes more money renting two suites instead of one.

Another idea is to offer a shared receptionist area for two or more tenants. Unlike a “true shared office”, a landlord will provide a central receptionist and seating area that would clearly define the tenants in the space as separate. This works best with a large rectangular type space. A receptionist could be placed in the center of the space. To the left is one tenant to the right is another. This alternative offers a number of advantages to the tenant. First, it gives “larger than life” exposure. The tenant appears to be larger in size. Second, it takes away the added cost of the receptionist, which a number of firms no longer hire to cut costs. Third, it allows the tenant to take advantage of lower rental rates found in larger spaces.

There are a number of other creative ideas to attract smaller tenants to larger spaces. Experienced agents of the 1980’s like myself, have seen these types of strategies work quite effectively in leasing larger spaces in a down market.