This may be, possibly, the most off-topic article I’ve ever done here. But I try to write only about things I know about, and, recently, I learned a lot more about commercial real estate than I ever imagined I would need to know.
My company, Fog Creek Software, is relocating. There’s nothing wrong with the brownstone we’re in, it’s just a tiringly long commute. Basically, we’re moving because of William Whyte‘s rule: virtually all corporate relocations involve a move to a location which is closer to the CEO’s home than the old location. Whyte discovered this principle after an extensive study of Fortune 500 companies that left New York City for the suburbs in the 1950s and 1960s. They always had big, complicated Relocation Committees which carefully studied all the options and chose, coincidentally I’m sure, to move to within half a mile of the CEO’s home in Danbury, Connecticut. Whyte also showed that these companies all tanked after the relocation. With, I believe, but one exception, companies that left New York City to be closer to the CEO’s house in Connecticut or Westchester had dismal stock performance compared to companies that stayed in Manhattan.
The dismal stock performance probably came from the fact that when you relocate more than a couple of miles, some employees’ lives would be too disrupted to make the move, so you lose a lot of employees, and all the institutional knowledge, skill, and experience that comes with those employees. While I was working at Viacom one of their companies, Blockbuster, decided to move from Florida to Texas after they hired a new CEO who lived in — Texas! What a coincidence! Only a small portion of the employees made the move. For years and years the business press watched agog as Blockbuster made mistake after inexcusable mistake, re-trying all kinds of ideas that had failed only two years earlier.
But I digress. We’re not losing any employees and we’re just moving across town, to a location that is an easy walk from every subway line in NYC and three mega commuter hubs, bringing us within easy commuting distance for 17,000,000 potential employees.
Temporary Space and Incubators
Step one in finding an office in New York: allow nine months. I am not kidding about this. It will take about two months to find the space, a month to negotiate, two months to sign the lease, a month for your architect to design the build out and three months for construction. If you run out of time on your old lease, chances are (look closely) you have a clause in there which doubles or triples your rent if you stay past the end. This is called the overhang and next time you negotiate a lease, you’ll remember to negotiate a lower overhang.
Nine months. You may think you can shorten that by taking pre-built space. The problem: there’s hardly anything pre-built in the office market in New York. Almost everything you see is going to be either completely raw, or it’s going to be a weird warren of dark rabbit offices with inexplicable bars between certain rooms, filthy carpet, and disgusting yellow-stained acoustic tiles.
What there is, if you have to move tomorrow, is temporary executive suites. These are the things you see advertised in the newspaper that say “Move Tomorrow! Plans from $100 a month!” What the ad doesn’t say is that the $100 a month is for a mailbox only, with everything else a la carte. If you really want an office in one of these executive suites you’re going to pay through the nose: about five to ten times as much as comparable office space. It’s like living in a hotel instead of living in an apartment, or flying Concorde to London. Yeah, it’s convenient, but is it really $10,000 a month convenient? Still, all the executive suites in the city are full, usually an honor roll of venture-capital backed companies working hard on keeping their cash burn up to respectable levels to impress the investors. This is because normal landlords hate venture capital funded companies. The few landlords in New York that rented to VC startups during the dotcom boom have learned never to do that again. Here’s why: venture funded companies only have enough cash to last a few months or at most a year, after which they have to raise another round. If they don’t raise the round, they close. Probably 80% of these companies close within a year. The way most leases are written, a landlord literally loses money if the tenant leaves after a year. If you’re venture funded, and your VC won’t sign a five year lease for you, you may be stuck paying the Rich Tax, paying $200 per foot (per year) to be in executive suites when the market rent is $20 – $30.
Another option is the so-called incubators. In New York City, we have TechSpace, EEmerge, Kickstart, and probably a few others. I am sort of surprised these places survived the dotcom bust, but they did, and they’ve lost their arrogance. They no longer act like VCs, they don’t care about your business plan any more, and they don’t want 5% of your pathetic worthless stock, they just want to get paid. They won’t even kick you out after 3 months any more.
Incubators are a terrible place for programmers, because they took the baby chick metaphor a bit too far. The scientific geniuses that built these places actually think that the closer you shove people together the warmer they will be and thus the faster they will grow. What you get at the incubators is a room the size of your bedroom with desks around the outer wall where you can cram 16 people, all for about three thousand bucks a month. Oh, you wanted a window? Make it four thousand. Incubators are a smidgen cheaper, per square foot, than the executive office space, but they are just not an acceptable long-term solution.
Normal Office Space
A quick survey of normal office space.
First, it’s usually not built, and if it is, somebody has probably been using it. If the walls are configured to your liking, you may be able to paint and recarpet it (about $7 per square foot) and move in. Otherwise you’re going to have to do construction. Plan on this costing $50 per square foot. So if it’s a 3000 square foot office, expect to spend $150,000 on the construction. I know, this sounds like a lot. While you are looking for offices, brokers will tell you that you can construct an office for less than $50 a square foot. They are lying to make the deal. Do not fall for it. The only way to pay less is if a lot of the work is already done (on our office, the demolition, ceiling, sprinklers, air conditioner, bathrooms, and finished floors were all done, so we’re hoping to spend $25/ft on construction.)
Update, Feb. 2006: Construction costs are up a lot in the city. Plan on $75/sq ft for a very minimal buildout. I’m serious. We did construction for about $30 in 2003, but that was with an incompetant contractor who did terrible work, took forever, and lost his shirt on the deal because he had underbid.
In today’s market, you can usually get the landlord to pay for some of this, probably $10 to $25 a foot. They will want receipts and stuff and they will only want to pay for walls and air conditioning ducts, not Aerons and plasma TV screens. Some landlords will also offer to do the construction themselves for you. If you take them up on it, you’ll get the cheapest possible construction and it won’t be very nicely designed, so you may be better off hiring your own architect and contractor.
In the office space market in the US, offices are categorized as Class A, B, or C. Class A means new, top-of-the-line construction. In New York, that means one thing only: modern steel and glass high rises. Anything else is not Class A. A classic old skyscraper from 1913 designed by Cass Gilbert with incredible detailing, beautiful gargoyles, a complete renovation from top to bottom and everything is spotless and new is still not a Class A building, even if it’s nicer than most Class A buildings.
Class B and Class C don’t mean anything, there’s no formal definition, so nobody bothers to use these terms in the city any more. There’s Class A and there’s Everything Else.
For the purposes of high tech startups, unless you need a whole floor of a skyscraper, forget about Class A. It’s not that you can’t afford it, it’s that they are not going to subdivide floors for you. These buildings are leased 10 floors at a time.
That leaves you with a wide variety of old buildings, often loft buildings, in various stages of renovation. The best ones have been recently renovated, the elevators are new, everything is spick-and-span and the lobby is nice if not glorious. The worst ones have a spanish deli as the lobby, the (one) elevator is manual and operated by a scary old man, and there are still a lot of clothing factories in the building operating heavy machinery that goes bonk bonk bonk all day long. Almost all of these buildings are family owned, although they might be managed by one of the large real estate management companies like Newmark or GVA Williams.
What If I Really, Really Don’t Want to Build?
There are a few buildings which cater to small tenants where the offices are basically built out and at most you’ll need paint and carpet. The Graybar Building near Grand Central, the Fisk Building near Columbus Circle, and the hugely unpopular Empire State Building. Graybar and Fisk always have spaces available on short notice at “market rents,” about 50% – 100% more than you’ll pay for raw space in the Garment District or Wall Street but reasonable for their neighborhoods. Graybar is a funny ghost town building, right on top of Grand Central; it’s full of offices of just-retired lawyers who live in Connecticut and can’t quite let go, so they keep an office in the Graybar building, but then they never really go there.
Do You Need A Broker?
In the commercial market, brokers are paid by the landlord. Usually something like 6% of the total value of the lease over its entire term. This is a lot of money for a little bit of work. So as soon as you let it be known that you are looking for office space, you will have brokers falling all over you.
You have the option of using a tenant’s broker. A good tenant’s broker does all the legwork for you, looking at lots of spaces to find one and then showing you only the best options to choose from. The trouble is, there are hardly any good tenant’s brokers. Most of them are just too lazy. The will tell you to meet them at Starbucks at 10:00 am, and they’ll bring a printout they made at 9:45 that you could have gotten online (more about that in a moment), and they’ll make you walk around with them while they get their act together and discover that these spaces don’t really exist.
Tenant’s brokers will tell you that they have the inside track on office space that isn’t listed, especially sublets. The best ones will, but only the very best ones. Most of them are just making the same printouts you can get yourself.
Bottom line: you don’t really need a tenant’s broker to show you spaces. OK, the other thing the tenant’s brokers will tell you is that they represent you, not the landlord, so they will have your interests in mind. This is vaguely true, but they’re still getting paid by the landlord, and they still make more money if you overpay, so it’s hard to trust them. If you’re worried about landlord sharks taking advantage of you, stop worrying about that. Why? Because you’ll have a good lawyer on your side when you sign the lease. You need a lawyer to review your lease anyway, that’s your real protection from the landlord, not a broker who gets paid by landlords.
Are there disadvantages to having a tenant’s broker? There are two. First, you may have to sign an exclusive. In today’s market, with vacancies skyrocketing and no new tenants, you should flatly refuse. There’s no reason to sign an exclusive. Just promise the broker that if you take a space which they showed you first, you will see to it that they get their commission.
The other disadvantage is that if a tenant’s broker finds you a space and you take it, they will be splitting the commission between the tenant’s broker and the landlord’s broker. That means the landlord’s broker only gets half the commission. That means, all else being equal, that the landlord’s broker would rather do those deals where they get the whole commission, when they have a choice. That means that if you’re competing for space with another potential tenant, and that tenant has his own broker and you don’t, then the landlord’s broker is going to like you much more… twice as much, in fact. Although theoretically it’s up to the owner of the building to decide whom to rent to, you can bet that the landlord’s broker will find ways to make the owner like you more.
Update, Feb. 2006: I’ve been told that many landlord’s brokers are salaried employees on the staff of the building management company who couldn’t care less and don’t really work on commission. So for larger space (10,000 square feet or more) it probably won’t hurt to hire a good tenant’s broker and sign a three-month exclusive, but make sure you’ve got a really good broker who will do the footwork to earn their commission.
How Do I Find a Space Without a Broker?
Easy as pie.
Next, check the Sunday New York Times. (Not online. The online version just redirects you to CityFeet, which has a superset of the print classifieds). Circle everything that looks appropriate.
If you want cheaper, artsy space, check the Village Voice.
Avoid two things: ads that sound like executive office spaces, and ads that are just pitches for brokers disguised as listings. You can identify these because they don’t give any details about the space, like the address. If the address is not in the listing, don’t bother responding, it’s almost certainly a broker who is fishing for potential tenants. He’ll tell you to meet him at Starbucks at 10:00 am where he’ll show up with exactly the same list you printed out from MrOfficeSpace.
Next step: do not call the broker in the listing. Yes, they can show you the space, but you don’t need them yet. First go to the building in the listing and see if you like the building. Check out the lobby. Read the list of tenants to see if they’re mostly software companies, architects, and graphic designers, or if they’re mostly clothing factories, importers, and methadone clinics. Check out the neighborhood. In the bad buildings, people get into the elevators talking to themselves. In the good buildings, people appear to get into the elevators talking to themselves, but they have a tiny earphone, so it’s totally different, they’re just on the phone.
Like the building? Here’s the next step, for which you should be reasonably well dressed. Go into the building’s service entrance and ask to speak to the super. Tell the super you’re looking for office space and you want to see the space in his building. He will show it to you. In better buildings, he may ask for a business card. That’s all there is to it.
Now, if you like the space, call the broker.
“What would have happened,” you may ask, “if I had just called the number in the ad?” Well, nothing terrible. The broker would have met you in the building lobby, and then he would have asked to see the super, and the super would have shown you the space. You see, the super has the keys and knows how to drive that cool manual elevator that goes to the floors where the fancy automatic elevators don’t stop because there are no tenants there.
At this point, if you don’t like the space, the broker will offer to show you a zillion other spaces. If he’s smart he’ll have the MrOfficeSpace printout that you also have. It doesn’t hurt to walk around with him and look at spaces, he may know the neighborhood and be able to give you the gossip. It’s worth spending some time talking to all the brokers you meet. Ask them what buildings have nice owners, and what buildings have nasty owners. They will lie a little bit about the buildings in which they have an interest, but if you keep asking and average the results you’ll eventually learn the reputations of the landlords in the neighborhood.
How Do I Know If I Like The Space?
I kept looking at spaces, not particularly knowing if I liked anything or not, and one nice broker said to me: “Don’t worry. When you find the right place for you, you’ll know it.” And he was right. The next day I walked into a place that was beautiful: natural light on three sides, a great renovated building, beautiful new wood floors; instead of taking notes I just wrote “incredibobble” in my notebook. That’s the place you want. If it doesn’t happen keep looking.
Gotchas to watch out for:
- If there are windows, figure out what might happen that would block your views. If the building is next to an empty lot or a “taxpayer” (one story building), as soon as the economy gets better, a building might go up there and it might block your view.
- Check out the bathrooms. Some buildings have really gross bathrooms and people forget to look at them.
- Sit quietly in the space for a few minutes and listen to all the noises. Are there factories nearby? Noisy people upstairs banging around? A noise you don’t notice when you’re walking around talking to a broker may be torture when you’re trying to concentrate on writing code.
- Make sure the building has 24/7 access. Some buildings in New York actually close.
- How are you going to get air conditioning? Is there something in place or will you have to install it? When you install it will it block your only window?
- Are there enough elevators? Older buildings with only one or two elevators can mean really long, irritating waits.
How Big A Space Do I Need?
Space is measured in RSF: rentable square feet. This is a number that bears only a fleeting relationship to the actual size of the space. I have seen spaces that are 1000 RSF which are the same size as spaces that are 3000 RSF.
How could this be, you ask?
Well, you don’t want to know. Officially you get RSF by taking the total size of the space and multiplying it by the building’s loss factor. That’s a made up number which they multiply the size of the space by, just because they can get away with it. It’s supposed to account for all the shared areas, like the basement, the elevator shafts (counted once for each floor of course), the exterior walls, the interior walls, the bathrooms, the lobby, the Starbucks next to the lobby, the staircases, the fire escapes, and the owner’s house in Queens including pool and garden.
Meaning — RSF is pretty useless. When they quote a price, it will always be quoted in dollars per square foot per year. Multiply by the size and divide by 12 to get your monthly rent, and this is the only figure you care about. Sign a lease based on the cost, not the square feet, or they’ll “recalculate” their loss factor the next year and raise your rent.
This makes it sort of hard to search for office space, and it’s one reason you have to look at lots of spaces (and bring a tape measure.) If you calculated that you’re going to need about 2000 square feet, look for places advertised between 1000 and 3000.
Find out about all the charges you’re going to have to pay. There are a couple of ways New York buildings especially like to stick it to you.
Some buildings don’t have separate electric meters for each space. Since they don’t know how much electricity you’re using, they just have to charge you based on the assumption that you are operating a 100,000 watt radio station with Times Square lighting. They’ll charge you something like $3 per square foot per year which is way more than you would spend if you had your own meter.
Some buildings make up things and put them in the lease. “Tenant shall pay $200 per month to maintain the decorative steel trim on the building,” my lease said. Hmm. Damn building doesn’t even have a steel trim. I made them take it out.
Escalations are another big issue. If the rent is x for the first year, it’s going to be x times the escalation in the second year, and so on. This amount should be agreed upon and not based on some weird fabricated thing like “tenant’s prorated share of the owner’s increased expenses from operating the building.” I don’t care about the owner’s expenses and I’m not paying for the owner to pass along the cost of his 2003 Buick LeSabre to me. Some buildings have a uniquely Manhattan corruption called “Porter’s Wage.” This means that every year, when they renegotiate the contract with the Porter’s Union, the percentage that those salaries goes up by is the percentage escalation that the tenants pay in rent. The theory was that a porter’s wage was correlated with the overall inflation in the cost of operating a building, but in reality buildings don’t have porters any more, and for some reason the porters they don’t have would get really huge salaries, if they had jobs, but they don’t, and the tenants are still paying for it.
Another thing the landlord will want to pass on to you is your share of the increase in property taxes. This is reasonably standard. They will even bill you for any money they spent “lobbying” (paying bribes) to get their property taxes reduced. Slimy but common.
How Do I Negotiate The Lease?
Theoretically, everything is negotiable. Practically, you’re going to negotiate these big items:
- monthly rent.
- months of free rent at the beginning (these days it’s not uncommon to get one month for each year of the lease, and even a couple more months while construction is going on)
- landlord’s contribution to buildout
- length of the lease
For the purpose of negotiations, there are a few things you can pretend to care about which you can later swap to get a better deal:
- pretend that you want 100% of the profit from a sublet. They won’t give it to you, they’ll give you 50%, which is actually better for you because it gives them an incentive to allow the sublet in the first place, and you can swap this for something else.
- pretend that you don’t want to pay a security deposit.
- pretend that you want zero overhang, so your rent doesn’t go up if you overstay your lease.
You may think you want to sign as short a lease as possible, because it “leaves your options open.” Actually you’re probably better off with a longer lease, for lots of reasons.
- Landlords like long leases, so they’ll like you more if you sign a long lease, and you can get a better deal.
- Rents are super low now. If rents go up, your lease becomes worth cash money.
- If you grow out of the space, the landlord will let you out of the lease if you take another space elsewhere from the same landlord.
- If you go bankrupt or close, the landlord is not really going to be able to get anything out of you. If you’re incorporated and the corporation signs the lease, you’re not personally liable. At worst, the landlord will ask the company’s officers to personally sign a good guy guarantee. This says that you will be personally responsible for the rent but only until the premises are vacated.
- If you need less space, you can probably sublet. You might lose some money on the sublet but you’ll probably make money. The landlord will help himself to half of your net profits from subletting.
- You’ll get more free months at the beginning with a longer lease.
- You’ll be able to negotiate more money for construction with a longer lease.
- The broker will get more money, so he’ll be more eager to make the deal happen.
All in all, there’s no reason to be unduly scared of long leases. You can start by asking for a three or five year lease, agree on the months of free rent and construction money, and then ask them how much more free rent and money they’ll give you if you take a seven year lease. (Logically, this should be proportional — doubling the length of the lease should double the free stuff).
There are thousands of good books on negotiating in general and even a bunch of books on negotiating leases. Read two or three if you’ve never done this before. Never, ever go into negotiations unless you have a good alternative. You should have two or three options you like and want before you try to negotiate.
After you negotiate the big items, get a proposed lease from the landlord and let your lawyer negotiate all the little details to his lawyerly heart’s content.
Do I Need a Lawyer?
Absolutely. First of all, the errors-and-omissions insurance you carry (you do have errors and omissions insurance, right?) requires you to have a lawyer review any contracts you sign. But it’s a great idea anyway.
I found a lawyer who works for another landlord. He spends most of his days in court trying to evict tenants. I thought he would be perfect to protect me from the likes of — him. And he was. As he was reading through a lease, he said to me, “OK, this paragraph, I really like this clause, I think I’m going to steal it and use it in my own contracts.” Pause. He reaches for a red pen and crosses out the paragraph. “But you’re not signing it.” This guy was great. He knew that the standard phrase in the lease where it talks about leaving the space in “broom clean condition” was a classic way to avoid returning the deposit. “Sure, it was clean,” the owner says, “but it wasn’t broom clean. Prove to me that it was broom clean.” We crossed out “broom” and wrote “reasonably.” You Need A Good Lawyer For This.
Here’s another reason you need a lawyer. The lawyer can say to the landlord, “Whaddaya mean if we’re 3 days late on the rent we get evicted? We want the right to be 15 days late!” When your lawyer says this, no offense is taken. He’s just the lawyer. But if you, the tenant, try to say it, the landlord will say, “What, are you planning to be late on the rent?”
Oh, It’s All Too Hard!
I know. I know. And it has nothing to do with writing software. But as soon as you sign the lease, you can hire an architect and start talking about the fun stuff, like where the pool table goes.
TenantWise has a lot of great articles about all this stuff, although you have to register to read it all, it’s worth it.
Crains New York Business covers the commercial real estate beat like no other publication. Read it for a few months before you need office space, especially pay attention to the boring stories about deals, so you know what the market is like and negotiate from a position of knowledge.
Read the last few months of news at CityFeet, too.
Discuss your experience on the Joel on Software New Yorker’s Forum.