Time to Reassess Your Retail & Commercial Real Estate Needs?

Rick Ybarra - Netsuite

In short:

• COVID-19 is battering the commercial real estate market. That puts some CFOs in a strong negotiating position with landlords.
• Big companies including Twitter, Facebook and Morgan Stanley are permanently shifting to more home-based employees. Will smaller firms follow suit?
• As physical shops remain closed, retailers are finding success with omnichannel and ecommerce.

Jack Dorsey’s message to his employees: You can work from home forever if you want to. It’s not as simple as that, of course, but Twitter’s CEO made very clear to the company’s (now largely remote) 5,100-person workforce that he has no attachment to physical office space. Other big firms including Apple, Google and Facebook have told most employees to plan on working remotely until 2021.

A May CNBC survey of 9,059 U.S. workers shows most are fine with that. When asked how often they’d like to work from home even when it’s safe to go back to an office, 19% want to make the WFH arrangement permanent, and 38% want to work from home more often than before.

Eighteen percent want to be mostly (9%) or completely (9%) in the office. Lure of yoga rooms, pool tables, microbrews and rooftop decks?

Of course, the luxury of this choice is limited to a subset of U.S. workers, and not all roles adapt equally well. CFOs, for example, are famously loath to close the books remotely, despite upsides. Still, it’s not just tech firms looking to make big changes. Morgan Stanley and Barclays have stated that they will dramatically shrink their office footprints. And plenty of small to midsize firms are reconsidering their commercial real estate needs for the foreseeable future, given that following social distancing rules and keeping employees healthy preempt most other organizational initiatives.

This presents yet another COVID-driven “who’d have thunk?” scenario: Price breaks on suddenly empty office space in cities, like Boston, New York and San Francisco, where real estate has been both hard to come by and brutally expensive.

Want to compare the per-employee costs for home vs. office vs. hybrid? We run down dollars-and-cents considerations here.

“We’ve been able to work basically frictionless remotely,” says Tom W. Derry, CEO of the Institute for Supply Management (ISM) and former COO of the Association for Financial Professionals. “No one’s in the office because the nature of our work is based on a laptop, Internet connection and the ability to connect with people. If we have that, we can do our work effectively.”

Derry predicts declining demand for commercial office space in the near future, with the caveat that the need for spaced-out work areas to accommodate social distancing could offset that.

“The rule of thumb is 200 square feet per full-time equivalent, and that’s a little cozy,” says Derry, who envisions more “hoteling,” where employees who want to work in the office can reserve space and time via an app or online.

The prototypical open office, with employees working elbow-to-elbow at close-set desks or communal tables, won’t return anytime soon.

“The idea of measuring ‘seat time’ as a proxy for productivity is way outdated,” says Derry. “I've had a conversation with our commercial broker and already said that going forward, we don't need as much footage as we have right now.”

Buyer’s Market

As some companies shed office, retail and even industrial space over the coming months, others will grab opportunities that they didn’t have pre-COVID. With more available space to choose from, for example, both purchase and lease prices may become more negotiable.

Ludo Boinnard, CEO of San Diego-based retailer 100%, which sells sports performance sunglasses, goggles, gloves and other gear, says right now he’s focused on helping everyone safely navigate the pandemic. Once the threat passes, Boinnard expects the company’s office footprint to remain intact, noting that it’s “lucky to own a good-sized building” that can accommodate current employees.

However, he is starting to see opportunities in the commercial real estate market, where companies are breaking leases or going out of business altogether. That could pave the way for outsourcers, like third-party logistics providers that support the ecommerce and D2C businesses that have made strides lately, to increase their presence.

“As we look at the risk/opportunity ratios in the U.S., we are considering signing on a 3PL in North America to handle our pick-and-pack daily business while also reducing staff by transforming our warehouse to purely pallet/master carton and sub-carton stocking,” says Boinnard. He’ll be looking for a 3PL with foreign trade zone (FTZ) capabilities covering both Asia and Europe, the latter of which makes up about half of the retailer’s business.

With three professional services companies under his direction, Edward King, CEO at Alliance Career Training Solutions in Salinas, Calif., is also considering a new real estate strategy in the post-COVID world. A CPA and former Fortune 50 CFO, King currently rents space for a law firm and separate career and corporate training schools.

The law business remains brisk, but his career training school shut down when California’s stay-at-home order went into effect. Like many other industries, the corporate training company was pushed into the virtual sphere, where employees are now learning online, from their own homes.

These shifts prompted him to push for savings.

“The commercial real estate market has changed dramatically in the last year and even more radically in the last three months,” says King. “I’m telling our landlords that if they want to encourage us to stay, that we’ll have to renegotiate. I see that as an economic decision.”

King isn’t taking those decisions lightly, and cautions CEOs and CFOs to carefully assess their situations before making hasty decisions to either scale back or scoop up recently vacated space.

“This shouldn’t be a knee-jerk reaction because what we’re seeing right now is not necessarily a clear, futuristic view,” King says. “There’s a lot of smoke in the air, and we’re all just trying to steer our way through it, especially where it comes to this short-term wave of employees working from home.”

If you’re analyzing fixed costs to extend runway, he says it’s a good time to downsize, renegotiate lease rates or move. Yes, you’ll incur upfront costs with a move, and downsizing in tandem with having some employees work from home has its own expenses. But the long-term savings may be worth it, especially if your existing space is one large, open bullpen where returning employees will have a difficult time distancing from one another.

“Consider fixing the problem by renegotiating your current lease or finding another location versus just cutting your real estate by 50% in response to what could be a short-lived trend,” he says.

Flipping the Switch

When ChurnZero switched over to a hybrid work-from-home employment model in 2019, it had no idea that it was setting itself up to deal effectively with a global pandemic The Washington, D.C., developer of customer success software was looking to alleviate employees’ extended commutes with a partially remote work arrangement.

“Traffic is horrible in our area,” says CEO You Mon Tsang. “We wanted to attract some new talent while also easing those commutes for current staff. That was the genesis.”

Employees were given the option to come to ChurnZero’s offices two to three days a week and work from home the rest of the time. Schedules are staggered so that not everyone comes in on the same days, allowing the company to maximize its office space across four groups of employees. In the post-COVID work world, Tsang envisions an expansion to six groups and even fewer days spent in the office, where occupancy maxes out at 60 people.

“With social distancing, that number will drop to 40 because most bench seating you find in the modern workplace is four feet apart,” says Tsang “Not all employees who want to come in full-time will be able to.” Other adjustments will include leaving conference doors open to support air circulation, the removal of every other chair from those group meeting rooms and more frequent cleaning and disinfecting.

As for ChurnZero’s real estate needs, he says the company will maintain its current square footage, mainly because any potential surplus will be offset by the new social distancing requirements.

“Companies that use cubicles may be in a different situation,” says Tsang, “But for those of us that use bench seating, our capacity basically evaporated by one-third overnight.”

Joined at the Hip

As companies try to balance extended shelter-at-home orders with employee safety and the need to normalize operations, real estate will surely play a role in CFOs’ cost control plans. After all, with high-profile companies like Twitter and Facebook cutting back on the number of people in their offices, small to midsize operations looking to hire and retain talent will likely enact similar approaches.

Before making those decisions, Ira Weinstein, managing principal for real estate for CohnReznick, an advisory, accounting and tax firm, says companies should carefully consider the value of person-to-person interactions, both in the workplace and in client-facing situations.

“Even though an office or industrial footprint seems easy enough to reduce, the face-to-face interaction that goes on inside of an office, factory or warehouse is extremely valuable,” says Weinstein. “You won’t have that if everyone is remote.”

While acknowledging the need for cash management right now, Weinstein echoes King in advising CFOs to look ahead to when a vaccine or treatment eliminates, or at least minimizes, the need for social distancing before breaking leases or selling off properties.

“Are you reacting to what’s going on right now?” he asks. “Or, are you preparing for the next two years?”

He advises retailers and restaurants with multiple locations to look backward as well. In the case of sites that were underperforming before the pandemic, CFOs should investigate whether it’s feasible to turn the keys back over to the landlord.

Leasing Realities

Plenty of companies are publicly asking for concessions, likely with the idea that their continued presence is an upside for landlords. For example, Starbucks wants a year’s worth of rent forgiveness for its approximately 9,000 U.S. company-owned stores, based on a 46% drop in earnings. Chipotle is also seeking help: “We are a strong tenant with significant growth ahead of us, and we expect our landlords will partner with us during this difficult time period,” Chipotle’s CFO, Jack Hartung, told investors in April.

With the understanding that no landlord is obligated to renegotiate a lease, Kevin Clancy, global director of CohnReznick’s restructuring and dispute resolution practice, says a rework may be worth a discussion. But gather data before you walk into a meeting, and aim for a win/win, inasmuch as that’s possible right now.

“If the obligor on the lease has little or no assets, and if default on the lease will only result in litigation with little to no upside or recovery to the landlord, then a walk-away is more likely among rational business people,” says Clancy.

Factors including whether a parent company or personal guarantee is involved can complicate the lease renegotiation process. Financial capability is another key factor. Using historical and projected financial data, if a tenant can demonstrate that its business wasn’t performing well pre-pandemic, and that it will likely be worse off post-pandemic, that helps create a case for a lease exit, which may make the most sense.

To the extent a landlord has flexibility to work with a tenant to achieve a longer-term goal, success of the tenant’s business with a modified lease may increase — or at least stem the decline in value of — the landlord’s property.

The problem right now is that many landlords are facing defaults from multiple tenants, many of them contemplating not reopening their businesses.

Knowing this, Clancy says negotiations should focus on balancing the risks and rewards for both tenant and landlord. For example, if the landlord is willing to take less rent in the short-term, thus allowing the tenant to get back on its feet as its business bounces back, that landlord could end up winning the longer game.

“Some level of cash flow from a tenant is better than no cash flow, especially if there’s limited demand for the space, should the tenant default and vacate” Clancy says.

He offers some advice for persuading landlords reluctant to play ball:

Consider your situation: Is there a parent company involved, as with some franchises or branch offices? A personal guarantee for the real estate lease that would leave an individual executive open to legal action? If so, acknowledge that and be reasonable in your asks because the landlord has leverage.

Bring the receipts: Gather historical and projected data and KPIs and do some scenario planning, with the goal of painting a picture of your company’s financial situation pre-pandemic, right now and in six to 12 months. Use this snapshot to create a case for a potential rent pause or reduction or lease exit.

Be creative: Is there a win-win way to address the issue without having to take legal action or default on an agreement? You’re likely not the first tenant to come knocking, so try to be the most innovative. For example, Clancy suggests providing best estimates of customer volume over the next several months and seeing if you can negotiate a variable lease structure that's tied to sales as opposed to fixed cost. “That way, if things don't pick up as expected, you and your landlord will be somewhat joined at the hip with a revenue-sharing arrangement,” he says.

For CFOs grappling with projections, Clancy recommends a thorough real estate portfolio examination with a focus on how many locations or square feet your company needs to run optimally over the next three to six months. Admitting that there are no easy answers to these questions right now, he says restaurants and retailers should factor in an average 50% drop in foot traffic, depending on location, as the country emerges from the pandemic and reverts to a state of normalcy.

Property owners in need of mortgage relief can find advice on forbearance options on the CFPB site. The CARES Act includes tax and foreclosure provisions applicable to the commercial real estate industry.

Finally, Rick Ybarra, principal at Avison Young Consulting Services in Atlanta, says CFOs should also factor their employees and customers into the equation when making real estate decisions, knowing that they’ll be affected by any move, closure or downsizing that happens over the next few months.

“If your company focused on having everyone in the office, look carefully at individual workstyles and factor in what does and doesn’t work,” says Ybarra, who also tells CFOs to avoid making short-term decisions in absence of a clear, long-term view.

“The decisions you make in the next 30 to 60 days could heavily influence what your company is doing six months from now,” says Ybarra. “Avoid making rash decisions that may be hard to come back from in six months.”

Bridget McCrea is a Florida-based freelance writer who writes about business, technology, and finance. She’s the author of five books and a contributor to publications like Logistics Management, Supply Chain Management Review, tED Magazine and Florida Realtor.

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