Free Rent as an Investment? Landlord Trades Office Space for Future Equity

A lot of offices are sitting idle these days, but that doesn’t mean users for them aren’t out there. Startups, for example, need space. Budding firms often blossom from in-person interactions in places where they can grow at their own pace.

But there’s just one little thing missing in a transaction between owners who have office vacancies and those who need to occupy it but don’t have the cash.

Hint: it’s the cash.

Oxford Cos., a real estate firm in Ann Arbor, Michigan, has a simple formula to help finagle that equation — with a concept in which it offers some tenants free rent in exchange for future equity in their business.

Oxford’s plan builds on another program it dubbed the “the instant office,” which it launched after asking some venture capital firms what exactly startups need, Wonwoo Lee, the company’s director of asset management, told LoopNet.

The answer, he said, was quite simple: “Flexibility. Startups need short-term, one-stop solutions. Especially when they are in between rounds of funding.”

Oxford builds out turnkey spaces, Lee explained, and then puts offices starting at as small as 100 square feet up for rent through a “simplified six-page, six-month lease” in which janitorial, utilities, Wi-Fi and sometimes even furniture is included.

With around 88% occupancy across its portfolio of 2.6 million square feet at 65 buildings around the Ann Arbor metro, Oxford has allocated around 13,000 square feet to the program.

If this is starting to sound like a familiar concept, that’s because it’s quite similar to “coworking.” Oxford doesn’t consider itself a coworking space provider, though, but a traditional landlord and property management firm that tries to offer “creative lease terms” for spaces that might be otherwise sitting vacant during these uncertain times — by carefully weighing those deals against its opportunity costs.

That’s where its new plan kicks in. It’s essentially the “instant office” for tenants on whom Oxford feels safe placing a bet.

Oxford teams up local accelerators like Ann Arbor Spark, University of Michigan Innovation Partnerships and TechArb, from whom it gets a pipeline of pre-vetted startups looking for space solutions.

“We will offer up to a year of rental abatement,” Lee said. “Free rent.”

Oxford offers a fixed-dollar amount of market-rate rent for up to a year, on flexible leases that are typically six or twelve months. “If the monthly rent is a thousand dollars, hypothetically, we would offer $12,000 in exchange for a SAFE note, which is convertible to future equity in the startup based on future valuation,” Lee explained.

“We’re talking about rental abatement of anywhere between $6,000 to $75,000. It really just comes down to how much space the tenant needs.”

Used similarly in other financial instruments to seed startup funding, SAFE, or simple agreement for future equity, is a type of contract created by one of the nation’s most well-known accelerators, Y Combinator.

Asked how the program pencils out, Lee explained where it fits on the balance sheet. “We have basically looked at what vacancy loss we’d have normatively projected in our portfolio and dedicated that chunk of space for the program,” Lee explained. “It's a good utilization of space that's currently just sitting vacant.”

But it is a risk, he admitted, noting that an evaluation of the program may only be feasible years down the road. In the meantime, he said, the philosophy is more nuanced.

This brings up an obvious question, Lee continued. “What does Oxford really get out of this?”

One, quite simply, is the financial play. “That fixed-dollar amount, commensurate to the rental abatement amount, then tags along to a third-party valuation of the startup when they go through their next series of funding — maybe that A or B round."

The other big one, he continued, is that any growing office user becomes a lucrative tenant and partner to have when you can offer them a revolving range of upgrades. “And that is absolutely a large part of the deal,” Lee said. “Once we get them in, we can help accommodate them in that problem of growth.”

Oxford hopes for a good retention rate after the short lease is up. “It's a good tool for landlords – for absorption,” he said. “And it’s a unique option for tenants. It's just trying to be creative with the question marks surrounding the future of office space.”

Of course, many startups don’t make it. “Private equity and venture capital firms spread a lot of seeds far and wide, hoping one or two will grow. That’s kind of what we’re doing here, but also from an angle of local economic development,” Lee said. “It's a certain level of commitment to the community — an investment in innovation in an entire communal ecosystem,” Lee said.

“It’s an emotional decision for the tenant, rather than a business one,” Lee continued. That was the insight he was given by an attorney who works with a lot of startups on formation and organizational documents. “So it has to fit the mold of that particular organizational need at that time.”

Another elephant in the room — “is office space even necessary anymore?” — also comes up.

Every entrepreneur must determine what physical space means to them in an age of remote and hybrid work, Lee responded. “How do companies drive culture, collaboration and mentorship?”

Lee is understandably bullish about the value of offices, and he hopes Oxford can help impart some educational value on those pegged with the dilemma of whether to take on space or not. “Some of the most innovative things happen completely on accident, right? It’s how some of the best songs are written. We’re talking about situations where there’s an expectation of societal exchange, in comparison to a scenario in which everyone could just as easily hide behind a screen while trying to figure out how to unmute themselves.”

Age is another factor that influences office demand, he added. For workers firmly into their career, the work-life balance of remote or hybrid work situations is great, he said. “But the roughly 40,000 students at the University of Michigan, for example, don’t usually want to go through four years of college just to sit on the couch and work remotely when they graduate. They want to be in vibrant places with socialization, collaboration, and mentorship.”

Physical space is also often critical to conveying the purpose of the organization, he continued, which is essential for the environment of a startup just taking flight.