Photo courtesy of the National Archives "the Electronic Numerical Integrator and Calculator and two programmers."

What real estate leases could learn from software contracts.

I recently negotiated a software contract with an extensive Service Level Agreement (SLA). It reminded me that a contractual mechanism that is so common in software and IT isn’t widely used in real estate. At first blush, using a SLA for a lease may seem like a stretch, but as leasing and facilities operations modernize and become more data-driven, an opportunity may emerge to differentiate and monetize space based on how it is run.

First, the basics look here. SLAs are frequently used to help buyers of software assure themselves that the software they are buying will live up to certain business objectives, such as uptime, response time or cure time for critical bugs. Organizations typically buy software to smooth workflow, and especially as more software is delivered over the web, it’s just as crucial how that software performs as what features are made available. SLAs typically administer benchmarks for key aspects of the software and enforce penalties on the vendor for software that doesn’t reach the SLA.

By introducing a SLA, software buyers can create a strong incentive for the software vendor to perform. Because the costs of people and processes using the software are typically an order of magnitude bigger than the software costs, software vendors typically use SLAs as a part of the competitive bid, demonstrating why they are better than the next vendor, and raising price for buyers that demand a strong SLA.

Now consider the market for standard office space. While every lease is different, brokers largely distill different properties into comparable costs and most buildings are price takers in the local market. A nice lobby, great location or low operating costs might give you a few dollars per square foot more than the next building, but the spread between building rents is remarkably small. Similarly, leases will vary in form dramatically, but typically they speak quite generally about the operation of the space.

Does this make sense?

Just like software, with information workers, the rent expense is a fraction of the total employee expense, and space that isn’t “working” is just as costly as software that is full of bugs. Your building may be run so much better than the building down the street, but beyond some marketing bullets on a flyer, superior building operations are not monetized in the lease.

What if they were?

What if you could demonstrate your response time, cure time and satisfaction rating of every tenant issue in the building and commit your building to meeting those numbers in a lease? How would a competing building respond? What if you could get a much higher rate, but accept some monthly penalties if certain detailed standards were not met? How would your asset manager respond? Could your biggest competitor in town match your offer?

Four years ago, David Kirkpatrick wrote an influential piece in Forbes entitled Now Every Company is a Software Company. His thoughts were remarkably prescient, and I can’t wait to see what building operations software enables in commercial real estate. Maybe it’s SLAs, maybe it’s something else, but the democratization of tools and data are going to lead to change, and for me that looks like an opportunity for real estate to look more like a software business.

About Tom Arnold

Tom Arnold is co-founder and CEO of Gridium. Prior to Gridium, Tom Arnold was the Vice President of Energy Efficiency at EnerNOC, and cofounder at TerraPass. Tom has an MBA from the Wharton School of Business at the University of Pennsylvania and a BA in Economics from Dartmouth College. When he isn't thinking about the future of buildings, he enjoys riding his bike and chasing after his two daughters.

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