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How Will Offices Deal With the Work-From-Home Trend?

By Matthew Frankel, CFP® - Dec 8, 2020 at 7:36AM

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From lease length to subleases, office REITs might have some tricks up their sleeves.

There's a lingering fear that office REITs will struggle in a post-pandemic world. While surveys have found that most people want to work in offices on at least a part-time basis, many companies could need less office space after the COVID-19 pandemic ends. 

In this Nov. 17 Fool Live video, two experts from The Motley Fool's real estate brand -- Millionacres real estate analyst Matt Frankel, CFP, and Millionacres editor Deidre Woollard -- discuss what office REITs may be able to do to keep their space occupied. 

Deidre Woollard: The other thing now is thinking about to is lease length, because traditionally it's offices have long leases and I'm starting to hear about some negotiations taking place about offices trying to negotiate less space or shorter time period, something like that. I think that's another thing that's putting a little bit of pressure on some of the office REITs although that may change now that people are feeling more confident with a couple of vaccines in the works. Maybe that won't be as much of a factor.

Matt Frankel: Office landlords do not want to get rid of the long lease length. That's really what they have going for them right now.

Deidre Woollard: Absolutely.

Matt Frankel: All REIT investors would do well to consider lease length when you're making an investment. That's a big variable. No matter how cyclical a business is, if tenants are locked in for 10 or 15 years at a time, it's a nice stabilizing factor, which is really what's helping office REITs. Even the inner city office REITs. Most people in New York haven't returned to offices yet, but their landlords are collecting 80 or 90 percent of their rent in most cases, because these tenants are locked in to another ten years on their lease. A lot of them are negotiating, like you said, maybe smaller spaces, but generally landlords are only modifying leases and we're seeing this all throughout the real world, where landlords are really only modifying leases in mutually beneficial ways. One of our REITs we follow is a movie theater REIT that we'll talk about in the next hour. They have primarily movie theater properties and they modify their leases in a way that reduces the rent on the tenant, but locks them in for a longer lease term. You're seeing a lot of these mutually beneficial lease modifications taking place, not necessarily where they're all just doing whatever the tenants want. In offices, they'll maybe reduce rent by a little bit, they'll maybe take a few thousand square feet of their space back or something like that. They do not want to get rid of that long term. In general they're modifying it to make the term even longer.

Deidre Woollard: The other thing that we're starting to see though is some subleases. Seeing it more in the retail sector, I think, than in the office sector. But there is some of that happening. Also seeing it in industrial, partly because with industrial if someone decides to leave there is much more of a, I think, a strong likelihood that there will be a tenant, whereas I think with office leases are probably a little trickier.

Matt Frankel: Yeah, it can be tough to sublease office space. But it's definitely, like you said, this has been part of the retail model for some time now when retail started. Retail has been struggling before the pandemic. It's really worth noting. They've had to get creative for years. The store-within-a-store model is really something you are seeing in retail. I can't remember it's Macy's (NYSE: M) or J.C. Penney (OTC: JCPN.Q) that has the Sephora, the store within a store model.

Deidre Woollard: Yes, that's J.C. Penney.

Matt Frankel: Okay. Where they're leasing some of their square footage to Sephora because they might not need 100,000 square feet so they are chopping their store up. You've seen that in retail for a while and you're starting to see that in offices. You might see some flexible space being leased out. Maybe a company has too much office space that they lease some out as a co-working type of arrangements. If they need the space, they could eventually take it back. But you're definitely going to see that as a way to reduce square footage without having to break a lease or anything like that.

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