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4 Reasons Why Financial Service Firms Are Growing More Conservative In Their Leasing Activity

The financial services sector, which accounts for a large portion of office real estate absorption, is leasing less space. 

Financial service firms — which include money managers, banks, insurers, investment funds, stockbrokers and more — have grown increasingly conservative in their office real estate usage dating back to the Great Recession, according to a recent Newmark Knight Frank report. 

This shift in real state needs can be attributed to four factors, according to NKF managing director of national market research Sandy Paul.

1. Increased Government Regulation

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Following the Great Recession, lawmakers have tightened financial regulations, enacting laws like the Obama-era Dodd-Frank Act, forcing banks and other traditional lenders to tighten their lending standards. The government's call for increased transparency in business dealings has weighed heavily on the finances of this sector, Paul said. 

"Regulations have increased and placed more financial burdens on some businesses," Paul said. "[Now firms are] basically trying to improve the bottom line."

2. Cost-Saving Initiatives

In line with most office-using businesses, the financial services sector is reducing its real estate to cut capital expenditures and boost profit margins. This is occurring in several ways. Some firms are moving to more tax- and business-friendly metros like Dallas Fort-Worth, Atlanta, Charlotte and Wilmington, NKF reports. Other companies are breaking up their operations, leaving front-office operations in core metros like New York and San Francisco while relocating back-end operations to smaller, more cost-efficient metros.

"There has been a lot of pressure on financial services firms in lower Manhattan to reduce costs. The costs of occupancy in Manhattan are so expensive, we're finding some firms are keeping the professionals in Manhattan but moving back-office operations to New Jersey," Paul said. "It is a way to reduce costs but keep [the offices] relatively close."

There has also been a notable trend of companies shifting offices to suburban markets, where there are ample opportunities to build campuses from the ground-up with amenities and a neighborhood character. 

"These firms prefer a campus setting but one that is walkable," Paul said. "Developers are learning that for suburban markets to be successful and attract office-using firms, they have to have restaurants, retail and all the amenities workers want. They're trying to find ways to activate these campus environments and that has proved to be successful with some financial [service firms]."

3. Space Utilization

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Consolidation has been a major trend for this sector. Large firms are both downsizing and merging several locations to reduce their overall footprint. Take Bank of America and Wells Fargo, for example. According to NKF, the banks used to occupy a collective 1M SF in Boston. Today the firms have reduced their square footage by a combined 339K SF, or 34% — and with very few staff cuts. 

In an effort to improve leasing activity, landlords are raising the concessions offered, such as tenant improvement allowances, pre-builds and other build-out programs to improve efficiency, NKF reports. 

4. Booming Fintech Firms

Though overall sector demand continues to slow, one area making strides is the ever-growing financial service technology sector, which the industry has dubbed fintech. Fintech companies include Square, PayPal, Stripe, Credit Karma and NerdWallet.

Fintech firms are expected to drive office demand going forward, NKF reports, filling space vacated by traditional banks and financial service companies. Paul said these firms are particularly drawn to locations in Silicon Valley, the country's tech hub.

"That's a market particularly suited to support fintech. You have a lot of owners particularly in tune to the needs of fintech tenants [in that area]," Paul said. 

Q1 Fundamentals Update

On a nationwide basis, office demand softened in Q1 for the second consecutive quarter, according to Newmark's Q1 National Office Market report. Tenants absorbed 4.3M SF in Q1, down from the 6.4M SF soaked up in Q4. This was a marked decline in demand compared to the past five-year quarterly average of 12.5M SF absorbed.

As for the 11 core financial service metros in the U.S., Dallas-Fort Worth, Boston and Atlanta recorded the strongest office absorption in 2016, while Wilmington, Orange County and Atlanta saw the largest single-year vacancy rate decline.