Space Exploration: How Will Banks Handle Unwanted, Costly Real Estate, Post-Covid?

With much of the US economy beginning to reopen for business, coronavirus or no coronavirus, capital markets participants are being typically risk-averse, with upwards of 90% of financial firms’ headcount working remotely, and seemingly a new firm every day saying it will implement extended work-from-home programs for staff, or allow employees to work from home indefinitely. The result is that these firms now face the prospect of paying for substantial amounts of office space that may remain empty for the foreseeable future.

Some of the costs associated with this space—workstations, software licenses, and the staff that use them—are still valid, because those paid employees are using the software licenses, whether they are at home or at the office. But for firms that don’t own their own space, rent—and for all firms, other costs, such as utilities, infrastructure, and maintenance of all the above—must still be paid, whether the space is being used or not.

“I think ultimately, everyone will return to the city once things shake out. With the short-term hysteria, we are seeing a lot of pricing adjustments to keep tenants. But firms have to figure out their strategy and what to do with excess space, and whether that will just be short term, for six months, or for a year,” says Peter Sabesan, managing principal at real estate company Cresa.

Working from home isn’t new, though the scale of work-from-home programs and the length of time that firms’ offices have been all but empty is unprecedented.

“More embracing of working from home has already been happening over the past four or five years,” says Anthony Woolley, head of business development in Europe at Ownera, a blockchain platform for digitizing ownership of digital securities. “I’ve seen a lot of big banks looking at working from home possibilities and asking whether it allows them to provide flexibility, run a geographically diverse workforce, and help from a business continuity perspective.

“Parallel with that, banks are working more closely with fintechs, and many banks have set up accelerators on their own premises, in a WeWork style. And in the last two or three years, we’ve seen the rise of banks as venture capital (VC) firms. Originally, banks’ VC arms tended to be quite separate from the rest of the organization. But in the last two or three years, banks have realized that if they are going to have a VC function, it should not be a classic VC function, but should be more strategic. Yes, the aim is to make money, but it should also be a strategic investment that is backed by one of the business divisions. So there is a lot of benefit to having those parties working closely and on-premise,” adds Woolley, who served as chief innovation officer at French bank Societe Generale prior to joining Ownera.

Cost Dilemma

Real estate is typically a financial firm’s second-highest expense, behind staff and above the cost of market data—which itself can run to hundreds of millions of dollars for medium- to large-sized financial institutions. Firms that own their buildings may be able to easily sell off or rent out unused space—although they may lose the right to name their building if their ownership and occupancy levels fall below a certain percentage—but those who lease space may be tied to lengthy rental agreements. And though landlords may be willing to offer rate cuts for leases coming up for renewal in the near term, they are unlikely to forgo long-term income by allowing clients to wiggle out of their leases.

So, for firms who can’t save money by reducing their space, one option is to find ways to make money from the space—either directly by subletting it, or indirectly by using it to foster some kind of longer-term investment, such as by using it to house companies in which a firm owns a stake, and by charging only nominal rent, to contribute to those startups’ profitability, and giving them access to the enterprise-grade infrastructure and office space used by their owners and clients.

With some startups—especially the new wave of alternative data providers—expected to be hit hard by belt-tightening measures resulting from the Covid-19 outbreak, financial firms that rely heavily on specific vendors, or which may have taken a stake in a supplier, want to protect their competitive advantage and their investment. One way firms can do this is by letting fintechs take advantage of their empty space, sunk infrastructure costs, and the expertise and input from on-site bank employees who would be potential consumers of a vendor’s services.

Certainly, there are some aspects of space occupied by financial firms that lend themselves to fintech occupancy. Tom Perigoe, an industry consultant who has designed and built out trading floors in past roles, including at Bank of Montreal, says the office space occupied by financial firms that has been designed and built to serve specialist use cases—for example, to house trading floors or support high-volume risk calculations or back-office processing requirements—often includes custom features such as an independent and “oversized” electrical supply; raised floors; additional heating, ventilation and cooling (HVAC) capacity; and infrastructure to enable high-density occupation. For fintech firms, the opportunity to move into such a ready-made environment, rather than having to invest in building those improvements themselves, could be appealing, especially if the bank can offer the space at a price point that reflects the scale and term of its lease, and the fact that those improvements have already been accounted for.

“In an office tower, floor space has different qualities and different price points, and therefore, different ‘values’ to a tenant—whether that’s the bank historically, or fintechs in the future,” Perigoe says. “Certain lines of business (those in a trading room) and supporting functions with a requirement for continuous operation require specialized infrastructure beyond that of the ‘base building,’ including raised floors, uninterrupted power via battery and diesel generator, and locally resilient IT infrastructure.”

Startups typically don’t have the resources to afford this kind of space, but could take advantage of banks’ existing infrastructure investments. “For startups, real estate can be very hard to find, and very expensive. So why not have banks partner with fintechs and provide space for them,” says Mark Kovarski, co-founder and CTO of Alegious Innovative Partners, a “startup studio” that works with entrepreneurs to incubate and accelerate innovative startup companies.

“I believe these large enterprises will start partnering with startups,” Kovarski says.

In fact, one of the startups Kovarski is working with is RedVault Analytics, an “intelligent lease optimization platform” that helps companies manage their real estate assets more efficiently and to build marketplaces around their office space. With so many bank staff forecast to remain working from home at least in the short term, this represents a “tremendous opportunity,” he adds.

Until now, the potential for large swathes of office space being empty had not been on firms’ radars, says RedVault president Paul Wilson.

“I believe the work-from-home option is going to continue to grow,” both as a way to de-risk rising costs as the world introduces Covid-mitigation exercises in the workplace, as well as to just prevent the spread of the disease, Wilson says. “The cost of real estate in a major city is $15,000 per person annually. So if people return to offices and need to practice social distancing, they will need more space, and that cost will go up.”

RedVault helps firms audit their real estate costs, and negotiate leases, which involves digitizing and extracting information from paper documents using artificial intelligence. Once digitized, the vendor can analyze that wealth of data to help firms assess their spend against an industry average, save money by making better decisions about their office space planning and spend on real estate and related services. But for firms tied into leases running 10, 15 or 20 years, encouraging fintechs to use their excess space would be an “excellent” use of existing resources, allowing firms to monetize their leases while safeguarding their fintech investments, Wilson says.

More Than Just Space

Those who have seen these kinds of initiatives work in practice note that to be successful, they must involve more than just the sharing of space: There needs to be an element of knowledge sharing, too.

“The potential for clients to want to unload unused office space to startups has been explored for years,” says Mike Gleason, partner and director at Bannockburn, Ill.-based IT services provider and consultancy Netrix. “The successful ones I have seen coordinate the office space with a curriculum—meaning they used the space more like a startup ‘lab,’ or internship center or mentoring program.

“Giving office space to a startup within a common vertical would have minimal returns without a full-blown education/mentoring program behind it. Startups would rather be in large co-working digital startup spaces like 1871, Cintrifuse, etc. … that can hold hundreds of startups and broader business educational programs, instead of a small space with only a few startups in it,” he says, adding that “it would need to be a large investment of people, capital, and education from an established business to make the startups profitable.”

Alexander Ross, investment director of Illuminate Financial, a venture capital fund focused on late seed and Series A funding rounds for enterprise fintech vendors, says there are advantages to co-locating in a firm’s offices—such as the proximity to key executives and partners within the firm—but adds that there are more valuable things than space alone. And while space-sharing may solve a short-term problem, it may create greater long-term challenges to organic growth if a vendor is perceived to be too closely linked to one backer.

“By being in a bank’s site, you have some immediate association with them,” Ross says, which can be a good or a bad thing, depending on different circumstances, adding that some degree of physical separation or “Chinese walls” would be of crucial importance to maintain the image of independence for other clients.

“I would value a ‘Proof of Concept or Pilot Center’ over a physical presence—an environment where fintechs can access the data and systems they need without using live client data, and cut through red tape so you don’t need a hundred signoffs from the CISO and others within an organization to rapidly test new solutions,” he says. “The emphasis here is on a standardized partnership agreement, legal framework, and tech environment versus physical location. For a bank to create a broader incubator initiative, they are probably better off working with a neutral third party, like Barclays’ Rise [the bank’s tech incubator, whose New York operation is run by tech startup accelerator Techstars] or the Fintech Innovation Lab.”

However, this approach can lead to separation between fintech investments and the businesses they are intended to support, since a separate “lab” is by definition not fully integrated into an organization, warns Ownera’s Woolley, whereas anticipated space issues created by the pandemic represent an opportunity for firms to create a tighter bond with their fintech investments.

“At Societe Generale, I created a space called The Greenhouse within our building. Because when we looked at it, the challenge was not reaching the fintech ecosystem, but bringing that into the company and having an impact on all employees,” by fostering spaces where bank and fintech employees can interact freely, Woolley says. “Another reason to bring these companies into your space, rather than keeping them external, is that they will be in the same space as their sponsorship and budget … and can benefit from the expertise you have across your organization, not just the specific domain they’re working in. And when they are in that space, there is the opportunity or the kind of casual interaction you might encounter in a WeWork, not just with specific teams, but with hundreds of employees.”

However, the very circumstances that have created this opportunity are also its greatest potential impediments.

“The biggest outlier here is the current market conditions. It has been stated that 69% of companies are shrinking their office space requirement, [while] co-working spaces have to redesign all of their facilities to social distance (and in turn, shrink the desk-to-tenant ratio), and startups are choosing to stay working from home and save travel and rental costs,” says Netrix’s Gleason.

But at the end of the day, a glut of empty office space should not be the driving force behind setting up a fintech incubator program—in part because it may be a short-term factor. Instead, it should be a catalyst for new approaches overall. “Spare real estate on its own is not a good enough reason to do this. Any initiative has to make sense to the company,” Ownera’s Woolley says. “Space is an enabler and a catalyst, but should not be the sole reason for doing it.”