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October 2009 |
Miller, Rubenstein,
Hoffman & Hawkinson
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Shadow space adds to real estate market challenges
 As companies around the country maintain bottom lines
through layoffs and cutbacks, commercial real estate continues to shudder under yet another recession-driven burden, a concept known in the industry as "shadow space."
Defined in its simplest form as leased but unoccupied office space that is not on the market, shadow space typically originates when a company scales back its business and does not attempt to sublease its excess square footage. That empty
space becomes invisible to the market radar, skewing critical factors that real estate professionals and analysts use to gauge market performance.
While present in all market conditions to some extent, remarkably slow periods experience quick spikes in shadow space because companies often hold off on marketing excess space for sublease. For some, the distraction and burden of
subleasing while trying to maintain a business in a difficult economy may not be worth the costs it would offset.
In other instances, business leaders see the marketing of surplus space as a referendum on company performance. They often hold on to space to avoid the stigma it may create in the minds of critical employees, customers and business
partners, who may view the need to offset occupancy costs as a sign of operational and economic weakness and thus, an unhealthy future.
Public companies face the additional burden of accounting considerations. When a public company puts excess space on the market for sublease, it is required to take an immediate write-down on the differential between the rent it currently
pays and the actual value of the space in today's depressed sublease market. In an economy where public companies have greater and greater pressure to improve bottom line performance, many firms simply choose to hold onto the excess space
in order to avoid the write-down.
Given the weight real estate activity carries as a sign of economic health, shadow space can be a serious detriment to a region's economic recovery. It can also stimulate future negative absorption, as a company that holds a good deal of
shadow space now will likely settle into less space when renewing its lease or relocating to another building when the current lease expires.
However, smart tenants relying on well informed tenant reps can leverage a building's shadow space in lease negotiations. While on the surface, a landlord with a well leased building may appear well positioned, significant amounts of
shadow space can be a sign of future problems and a landlord who will be motivated to increase concessions to keep current tenants and attract new ones.
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Recession drives new space design
 As a sliver of light peers above the economic horizon, the
echoes bouncing around our now sparsely populated work places have started to reverberate with an alarm for change in the way we leverage office space design.
With a lot of space and fewer remaining employees to fill it, many companies are responding to the recession by consolidating employees into denser, more collaborative spaces that encourage interaction and foster a sense of community.
Moreover, organizations are discovering that today's workforce, especially younger, tech-driven professionals, actually prefer tight-knit work environments instead of private offices and the rows of high-walled cubicles that for many years
defined the pace of growth in the typical American office building.
For many, this space usage trend simply reflects the socially networked "instant feedback" mentality of today's workforce. Companies that rely heavily on employee ingenuity, such as marketing, design and tech firms, can quickly benefit
from the interaction close quarters encourages. Eliminating physical dividers, turning conference rooms into shared spaces and pairing employees at a single workstation are a few of the design techniques being used.
While the need for private offices and conference rooms will always be essential to many professional work environments, a less stationary workforce reduces the need for excess furniture, hard walls and break rooms. And, open floorplans
are typically cheaper to build out, more efficient (from a square footage per employee standpoint) and offer ongoing flexibility.
Companies that are locked into leases with excess space have to consider measures such as subleases and lease assignments if they are looking to reduce costs. However, going forward, many firms will actually reevaluate their future space
plans. When renegotiating their leases or relocating to other buildings, they will gravitate toward a more open space plan that affords more flexibility and space efficiency than more traditional layouts.
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Green construction is paying off
 The completion of a substantial green retrofit on the Empire
State Building and its tenants' collective embrace of the plan has substantially raised awareness of the increased value today's office tenants are placing on such improvements.
Now, the owners of Chicago's Willis Tower (formerly the Sears Tower) are following suit, as evidenced by a recent pledge to cut energy usage by 80 percent with a $350 million investment in the retrofits. And in Los Angeles, the owner of
the 2.5 million square foot City National Plaza recently invested $46 million to cut energy costs by 35 percent.
For a number of years, the barriers to bettering a building's energy usage existed in landlords' skepticism that investments in environmentally-conscience construction could provide a return. However, the occupancy rates of office
properties that are LEED-certified are higher than those that are not, according to a study by CoStar Group, Inc, a national commercial real estate information company.
Additional proof that green construction can pay off can be found in a recent report by the Urban Green Council that cited construction costs per square foot for LEED certified high-rise properties averaged just 1 percent more than
non-LEED buildings. The study used 38 multi-family properties and 25 commercial office interiors.
Commercial office space tenants dedicated to reducing their carbon footprints can take solace in the fact that they are helping drive the switch in thinking on the part of property owners. In conjunction with buildings that are more energy
efficient, tenants who execute energy savings plans of their own will help increase the commercial real estate industry's contribution to improving our environment. And since commercial office space makes up close to 20 percent of the
country's energy usage, this contribution can be significant.
What's happening in New York and Chicago will take time to filter down to landlords across the country. So while an industry-wide embrace of the value of investing in energy-reduction efforts is not yet fully realized, a number of large
hurdles have been cleared.
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Georgia offering tax credits to jump start economic development
 Historically, some of the best and brightest early stage
companies have been leaving Georgia for other states that can offer financial incentives that Georgia traditionally has been unable to match. But this is about to change. We are very pleased to learn that Georgia has just instituted a new
economic development plan to encourage early stage companies to locate within the state.
Specifically, since early stage companies (often in the technology and biotechnology fields) are not typically profitable in early years, state income tax credits do very little to incentivize young homegrown companies to stay in-state or
out-of-town firms to seriously consider Georgia as a relocation option. But according to Sterling Wharton, executive director of the Centers of Innovation at the Georgia Department of Economic Development, now under revised legislation,
eligible pre-revenue companies can now accrue research and development tax credits to use against payroll withholding taxes. These startups can accrue the tax credits for five years and must use them by 10 years. Eligible R&D costs
include salaries, capital expenditures, contractor fees and leases for equipment and facilities. If the company does in fact turn profitable, up to 50 percent of the tax credit can be applied to net income
For now, Georgia is the only state in the country that offers startups such an incentive. We believe this may be the catalyst that Georgia has been looking for to reignite local economic growth. While young companies may not immediately
increase employment in a significant way, they do build a foundation for the future. There are tremendous technologies coming out of Georgia's universities but too few have resulted in local company growth. With a more hospitable
business environment for young companies, this trend is bound to change.
We congratulate the State of Georgia on its leadership and foresight and look forward to following the success of this new program.
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