Today, it’s an entirely different ball game. Rather than trying to fit more workers into less space, office landlords and tenants are now using Tenant Improvements (TI) to make workers feel more comfortable about coming into the office instead of wanting to permanently work from home.
In this article, we’ll take a look at how office TIs are creating potential opportunities for building owners to set themselves apart from the competition as a result of Covid-19.
Decision Making During a Pandemic
Economic dislocations like a pandemic can cause paralysis in landlord decision making.
Some landlords prefer to move cautiously when it isn’t clear how long tenants will be concerned about the virus, or if an effective vaccine is found quickly.
However, here at Feldman Equities we believe that crisis creates opportunity.
Instead of waiting for the market to tell them what to do next, experienced landlords are using office TIs and capital improvements as a negotiating tactic for signing leases, growing market share, and increasing cash flow while the competition prefers to sit on the sidelines.
Keeping Office Space Healthy
In the fight to improve workplace health, every little bit counts. A recent article from Forbes noted a number of ways landlords and tenants can work together to keep office space healthy, ranging from common-sense changes, to smart Tis, and capital improvements.
- Declutter desktops, break rooms, and shared spaces to operate in cleaner, more organized, and healthier ways
- Hygienic decor choices such as vinyl, laminate, and durable fabrics that can withstand frequent cleaning and sanitizing
- Touch-free systems including using smartphones and key fobs to open doors and control lighting and hands-off fixtures in restroom improve workplace health and also save water and energy
- Telecommuting should be rethought as businesses and workers realize that while technology allows remote work to be done from anywhere, office spaces are best for collaboration and communication
- Flexible spaces must strike a balance between bringing people together to collaborate while maintaining safe personal space such as expanding aisles, and reconfiguring rooms and overflow areas for company-wide meetings
- Energy efficient features such as louvered windows and heat recovery systems allow office buildings to circulate more fresh air year-around, and are a holistic way of using ventilation and window systems to keep the workplace healthy
- Mechanical upgrades such as using air filters to trap airborne contaminants and keeping office humidity levels at about 50% may limit virus growth while boosting the infection resiliency of employees
Over in Europe, Cushman & Wakefield has introduced the 6 Feet Office, which is the firm’s conceptual idea of how to prepare to return to the office. The concept consists of six elements, including acting responsibly, staying 6 feet from each other, always walking the office clockwise, and replacing desk pads daily.
Of course, there’s much more to fighting the spread of Covid than straightening up desks, walking in the right direction, and maintaining six feet of social distancing.
Next, let’s look at how landlords can use technology and mother nature to make strategic tenant improvements that make offices healthier.
Fighting Covid With TIs, Technology, and Nature
Capital improvements can create a competitive advantage in the Covid-19 era, according to NAIOP. The commercial real estate and development association reports that building owners who are actively considering capital improvements to fight Covid have the potential to create durable competitive advantages that may last well after the virus runs its course.
Improvements to reduce the transmission of the virus such as HVAC system upgrades, UV lighting technologies, and touchless remote controls could help office building owners to lease more space and increase market share.
Bipolar Ionization Ventilation Systems
Bipolar ionization technology releases charged atoms that attach to and deactivate harmful substances like bacteria, mold, and viruses.
As Business Insider notes, bipolar ionization has been used in the US since the 1970s to control pathogens in food manufacturing. The technology has also proven to be effective against SARS, and various influenza strains, and could be a secret weapon in the fight against Covid-19.
By integrating bipolar ionization technology into HVAC systems, oxygen molecules from the air are converted into charged atoms that then cluster around microparticles such as bacteria and viruses. The process also provides continuous disinfection by attaching to breath droplets and dust particles, then enlarging them so that they are more easily trapped by HVAC filters.
At Feldman Equities, we piloted several ionization systems to evaluate which would be the most effective in our buildings. We settled on the REME HALO system by RGF, which was found by a third party study to be 99.9% effective in killing Covid-19. We’re now in the process of integrating these systems into our HVAC across the portfolio, especially in common areas. The REME HALOs don’t just kill Covid: they also eliminate allergens and other airborne illnesses. We expect these systems to be an important marketing point for years to come as tenants seek out offices with “wellness” features.
Improved air filtration is one of the recommendations made by the EPA to help reduce airborne exposure to the virus. Hospitals such as Johns Hopkins and the University of Maryland Medical Center, terminals at LaGuardia and LAX international airports, and office space owned or managed by Feldman Equities in Tampa and St. Petersburg are already using bipolar ionization technology and UV light.
Natural Sunlight and UV Rays
Sunshine and UV-C rays could also play a major role in battling Covid-19, according to Forbes.
Virologists at the National Institute of Allergy and Infectious Diseases have found that light provides protection against diseases such as Covid-19. While the virus remains stable on materials inside of a building such as metal or plastic, it doesn’t last nearly as long outside in the sunlight. Researchers at the National Biodefense Analysis and Countermeasures Center agree that natural sunlight may be effective as a disinfectant for contaminated materials.
Ultraviolet UV-C light, between 200 and 300 nanometers, is potent against many bacteria and some viruses. Using artificial UV-C in indoor spaces such as offices and workplaces could help limit the spread of Covid-19. In fact, Far-UV-C light has been found to be effective against two relatives of SARS-CoV-2, deactivating 99.9% of the viruses in 25 minutes.
In addition to virus-fighting technologies like bipolar ionization and UV lighting, there are also several things building owners can do right away to help make office space safe.
Protective panels between desks and work areas can help put office workers at ease, while glass walls can provide Covid resistance while creating the feel of open space.
Signs on doors and floors, infrared thermometers used to check temperatures as people enter the office building, along with readily-available hand sanitizers and capacity limits in common areas also create healthier office space.
Why Companies Want Workers Back Into Offices
It’s perfectly logical to ask why office landlords and tenants want their workers to come back to the office in the first place. After all, why spend so much time and money on making office space healthier when people can work remotely?
As JLL recently noted in its 2020 First Look Navigating Post Covid-19 report, despite the impact that the pandemic is having on office owners and occupiers, many elements of how and why people work won’t be changing due to Covid-19.
The firm lists three main reasons why many companies want their workers to return to the office.
It’s true that most people can work from home. However, corporate clients have learned that true innovation usually requires people to be in the same room to solve a problem together. Solving problems in the fields of engineering, computing, and design requires a team effort .
Work from home makes it difficult or impossible to develop or maintain a corporate culture. Although some current level of a company’s culture can be sustained through video conferencing, creating trust or sharing values and ideas requires people to actually be together. By establishing a defined corporate culture, companies gain a competitive advantage with shared experiences, challenges, and triumphs.
Remote working is fine for rote tasks such as data entry or executing projects that are pre-planned. But when people are scattered across different locations it’s difficult to quickly pivot on enterprise-level operations. Today, businesses are increasing subject to disruption from new technologies or upstart competitors threatening existing business models. These challenges are best solved when people can work together face-to-face to solve particular issues.
How Covid TIs Can Increase Cash Flow
Cash is king, especially during a pandemic and economic recession.
Pre-Covid, landlords traditionally viewed tenant improvements as a cost of doing business to land a new tenant or retain an existing one. However, there are also several ways that TIs can now help to increase cash flow.
1. CARES Act
Commercial real estate firm CBRE notes that the Coronavirus Aid, Relief, and Economic Security (CARES) Act signed into law the end of March 2020 created two key provisions for taxpayers who own real estate.
Qualified Improvement Property (QIP) Rule
The QIP Rule states that any building capital spending from 2018-2020 can be immediately written off, excluding improvements made for enlarging the building, work on elevators or escalators, and some categories of structural framework.
Prior to the CARES Act, a landlord spending $300,000 in TIs would have had an annual deduction of $7,692 for 39 years. Under the QIP Rule, the entire $300,000 tenant-build out expense can be expensed in the same year.
Net Operating Loss (NOL) Carryback Rule
The NOL Carryback Rule allows building owners to offset taxable income to reduce tax liability. Net operating losses incurred from 2018-2020 may be carried back for five years.
NOL carryback rules were modified by the CARES Act in three ways:
- Carryback: NOLs incurred in 2018, 2019, and 2020 may be carried back five taxable years
- Carryforward: No limitation
- Taxable Income Limitation: NOL deduction up to 100% of taxable income in 2018-2020; NOL deduction limited to 80% of taxable income after 2020
2. Energy Efficient Commercial Building Deduction
Tax deductions for energy efficient commercial buildings and improvements have been extended through the end of this year under Section 179D Energy Efficient Commercial Building Deduction.
This provision allows a tax deduction of up to $1.80 per square foot for energy efficient property in three categories: Interior lighting, HVAC systems, and Building envelopes. The deductions apply to newly constructed buildings or leasehold improvements made after 2006.
3. Structuring Leases Post-Pandemic
As GlobeSt.com reports, many common lease provisions have become outdated due to the pandemic.
When renegotiating office leases with existing tenants or leasing new space, landlords can take the opportunity to review and revise standard office lease provisions such as operating expenses and base year calculations.
Operating expenses are costs incurred by office landlords for building operations. Although in many cases these expenses are passed through to the tenant, there are normally operating expense caps and limits to what landlords can include in these charges.
Office landlords today are incurring significant costs to implement operational and physical building upgrades to comply with public health and safety recommendations. To help recover those expenses, landlords should consider adding the right to include safety and security-related improvements and modifications and capital expenditures as part of the operating expenses.
Base Year Calculations
The base year is the first year that a tenant occupies office space and is used by landlords to determine a tenant’s share of operating expenses from the second year onward. In each following year of the lease tenants pay their proportional increase of building operating expenses.
However, if there were significant one-time costs incurred by the landlord due to Covid, office landlords should consider excluding those one-time costs from the base year. By removing pandemic-related improvement costs from the base year calculation, landlords can avoid potentially inflating the base year for operating expenses and instead pass through to each tenant its fair share of expenses.
Even if Covid is quickly brought under control, office building owners shouldn’t stop using technology, tenant improvements, and mother nature to make office space safer and healthier.
While many businesses continue to reevaluate their office space requirements, other companies understand the advantages of bringing workers back to the office. Proactive landlords will continue to make TIs to attract tenants, increase market share, and add value to the office buildings under management.
Sign up to learn more about how to invest in office buildings and to get early access to our next investment opportunity.