With the start of the new year and with the stock market continuing to break new levels, there’s a strong sense of optimism in our economy. As office vacancy mirrors employment rates, we are seeing vacancy rates continue to fall and rents rise nationally. Like the stock market, the office leasing market has its ups and downs. Maybe as an office tenant you were fortunate to lock-in low rents for a long term. But as companies grow, the demand for office space continues. Having 20+ years representing tenants during the office leasing cycles, here are some ideas on how to best navigate today’s increasingly landlord favorable markets.
Watch the Clock. Time is the greatest asset in any negotiation and even more important in a landlord favorable market. In a tight market, where some leasing options may be “here today and gone tomorrow”, time is needed to identify those coming available in your timeline. For example, there is the prospect of “shadow space” which is space currently occupied by a tenant that will be available for lease in the future after that tenant moves to another building (including one under construction). Many times these “shadow spaces” are not listed as their timing is not immediate.
Formulate Budget. By engaging a multi-disciplined project team, a tenant should formulate a comprehensive project budget to avoid surprises. This exercise will also identify opportunities for savings. For example, in some markets (including Downtown Chicago), we are seeing more landlords engage in fully furnished spec office construction from small suites to full floors. These arrangements can save the tenant considerable capital on relocation.
How much space do you really need? Tenants today are using space much more efficiently than in years past. Engage a design professional to help formulate a space program to determine your true space needs. While rents might have gone up, you may find out that you need less space and actually save money.
Auction Your Tenancy. Like any market, the office leasing market is a dynamic process. While landlords and their agents will paint a picture of it all being in their favor, savvy tenants will create their own market. Namely, they will “auction” their tenancy among competing landlords. To effectively create such an auction, there needs to be a credible threat of relocation and that requires a plausible timeline.
What comes up, must come down. Bull markets don’t last, and neither do landlord-favorable office markets. Tenants should explore leasing with the mindset that the market and economy will cycle down over the course of their lease term. Accordingly, tenants should maximize flexibility in any lease. See our blog for ideas on how to maximize flexibility in your office lease – https://www.blackacreadvisors.com/index.php/category/options-rights-and-renewals/. Along these lines, tenants should have an early termination right (or contraction right) which will allow them to renegotiate their lease if the economy deteriorates and rents fall. Tenants should also safeguard their interests and obtain a Nondisturbance Agreement from the building’s lender in the event of foreclosure; see our blog – https://www.blackacreadvisors.com/index.php/2010/12/plugging-the-lender-loophole-tenants-need-nondisturbance-agreements/.
Look under the Building’s “Hood”. Tenants should have a 3-prong analysis in examining buildings they are considering leasing:
What are the buildings underwriting assumptions? With robust office building sales, many buildings are being purchased with aggressive underwriting assumptions. Tenants should try to ascertain the building’s assumptions as to rent, vacancy and ownership’s investment philosophy. For example, a short-term holding owner will want to maintain a higher “face rent”, but may be more willing to offer more concessions, i.e., free rent, cash allowances, etc…
What is the building’s debt structure? In frothy markets, it’s not uncommon for office buildings to be highly leveraged which could lead to trouble if/when the market weakens and the landlord needs to refinance the debt. Note, most commercial loans are short-term (e.g., 5 years) and typically interest only.
What is the tenant stack? Another measure of a building’s stability, is its rent roll. Who are the major tenants? When are major roll-over points? What’s the outlook for the major tenants?
Design Considerations. In designing space, tenants should accommodate flexibility. If business continues to grow, what is the best way to expand the space with minimal disruption and cost? If business goes the other direction, can it be easily subdivided for subletting?
Blackacre Advisors LLC
DISCLAIMER. Our writings are from a real estate transaction perspective and for informational purposes only. Nothing herein shall be considered legal, accounting, tax, or architectural advice. Please consult with the appropriate professional(s).