Mariwyn Evans writes about commercial real estate for REALTOR® Magazine. You can reach her at email@example.com.
Commercial Real Estate: Tenants Take Control
Good brokers can make money in any market, but fewer tenants and more concessions means you have to market and negotiate like never before.
May 1, 2009
If you’re lucky enough to be on the tenant side of the commercial leasing equation these days, you and your client are sitting pretty. Even smaller tenants are in a position to ask for—and get—some of the best leasing deals seen for two decades.
"Everything is on the table in a lease negotiation today. It’s easy for an office tenant to grab two to four months’ free rent," even in New Orleans, relatively insulated by the oil economy, says Richard Juge, CCIM, SIOR, owner of RE/MAX Commercial Brokers there.
If you’re sitting on the owner’s side of the table, the view’s not quite so appealing. "Sometimes, it seems as if prospective tenants have brought out their Christmas wish lists," jokes Bill Gladstone, CCIM, SIOR, an office leasing broker with NAI CIR in Harrisburg, Pa. "People get a certain perception of the market and think they can get anything."
Even in a market with a 96 percent occupancy, like medical office buildings in Seattle, tenants are asking for rent concessions, says Paul Carr of CB Richard Ellis.
"It’s the psychology of watching news reports and expecting the market to get worse. It’s required some re-education of tenants on our part." Other owners are going with the concession tide. One is even giving away a new Smart car to brokers when a tenant signs a substantial lease.
Many multifamily properties, too, are moving into free rent territory, says Greg Martin, CPM®, with Draper and Kramer in Chicago. A glut of unsold condos, and renters and former home owners doubling up or moving in with family, add up to higher vacancies in markets like Chicago. And higher vacancies translate into one or two months of free rent for prospective tenants as well as free utilities and parking, says Draper and Kramer’s marketing and leasing director Lynette Vander Heyden.
Of course, the size of the lease and the creditworthiness of the tenant, as well as the owner’s financial position, affect what sort of deal can be offered. In many cases, loan documents prohibit owners from letting a property’s cash flow drop below a certain level, says Greg Schenk, SIOR, who exclusively represents tenants at The Schenk Co. Inc. in Columbus, Ohio. Owners with significant equity interest in a building have more flexibility to negotiate. (See Commercial Outlook: National Leasing Projections chart)
Find the Strong Tenants
Rent concessions aren’t the only challenge. Finding tenants in this era of downsizing requires brokers to work harder and market more aggressively than they have in a decade. "You have to get very aggressive and really pound the phones," says Ed Kearney, who specializes in industrial and warehouse space with Sperry Van Ness/Kearney Commercial Group in West Palm Beach, Fla. Like many practitioners, Kearney has ramped up his e-mail marketing with strategies like purchasing a list of top trucking companies that might need his warehouse properties.
Reaching out to brokers as well as tenants is also more critical than ever. To spark new marketing ideas for his leasing team and better assess the competition, Larry Culbertson, CCIM, who heads The C Group at Keller Williams Commercial in Atlanta, started a "visit the winners" program. It works like this: High-occupancy buildings in a marketplace hold an "open house" so leasing brokers can tour the facility, ask questions about amenities and incentives, and discover what the building is doing right. "Commercial brokers often have a reputation for not wanting to share information, but we’ve had a great response," he says.
You can also be proactive by working with city development authorities to reduce permit costs or allow new uses for vacant space. "Maybe you think your retail center could increase traffic with an ice cream shop, for example. Work with city officials to waive fees and make the move more attractive to tenants," suggests Mahnaz Khazen, CCIM, owner of Coldwell Banker Commercial Bay in San Jose, Calif.
To ensure that deals get done, target tenants with the cash or the business model to weather the downturn. On the office side, look for businesses such as accountants, bankruptcy lawyers, and outplacement agencies that will do well in tough times. In retail, focus on retailers with cash reserves such as Forever 21 and Kohl’s, says Khazen. She is also finding that retail strip owners are more willing to lease to smaller mom-and-pop retailers, especially if they’re able to pay a few months’ rent up front as a security deposit.
Be Cagey on Concessions
"Price is still the best way to attract or keep at tenant," says Kearney, but you can make concessions less onerous for owners. Spread any free rent over the term of the lease rather than offering it up front. "At least that way, the tenant is paying some rent," he says. Spreading out free rent also makes it less likely the tenant will just use up the free rent and move on.
Another option is to offer free rent up front, but add on the extra months to the end of the lease, extending the overall lease term, says Gladstone. Using up free rent early may do less damage to a building’s cash flow and value when it’s time to sell, he notes.
Another way to minimize the long-term damage of concessions is to offer a shorter lease term to tenants. "We suggest that owners who have a stronger tolerance for risk offer a two- or three-year lease instead of a five-year one so that they can get the benefits when the economy recovers," suggests Neil Shupak, a Philadelphia-based broker with GVA Smith Mack. Other options are to build in a rent increase after three years or to charge retail tenants a higher percentage rent.
Owners can get another boost to cash flow by spreading out leasing commissions over several quarters, notes Culbertson. "We’ve been offering that option to a few owners for about a year; now we’re doing it more broadly," he says.
Keep the Tenants You Have
While landlords will offer a lot to find new tenants, "the biggest challenge today is actually keeping the tenants you already have," says Culbertson. Start by approaching office tenants with good credit a year or more in advance of lease expiration and offering the opportunity to extend a lease, suggests Bill Finnegan, an office broker representing owners for GVA Smith Mack.
"Tenants don’t want to spend a nickel on moving and they don’t want to rewire," so if you make a reasonable offer, they’ll often stay, he says. In some cases, the deal will also let tenants reduce their overall square footage. To offset lost revenues from this returned space, Finnegan has been offering these small parcels as temporary "plug and play" spaces.
Educating tenants about the cost of relocation is another way to make staying put seem like a sound financial decision, says Schenk. "It can cost $25,000 to move even a moderately sized office tenant, plus another $2 to $4 per square foot to remove cabling for phones and computers." Retail tenants face the significant added risk that their customers may not follow them to a new location, even a nearby one, he adds. And all tenants that move face business disruption and lost productivity.
It also pays to be proactive if you think your tenant may be facing financial troubles that could lead to the inability to pay rent. "Get into their businesses a little bit. Check to see if retail and office parking lots are full, and stores have inventory," says Culbertson. If you see signs of trouble, consult with your owners and then "open a dialogue with the tenant about taking a smaller space or temporarily lower rent."
Make It Work
While it may be painful to give out concessions and watch owners’ cash flows fall, "skilled commercial brokers can make money when the market is moving up or moving down," says Juge. "It’s all a matter of getting educated and adjusting to the times." For the next few years at least, negotiating and the ability to understand and respond to tenants’ needs and challenges will be the skill sets in demand.
It’s also important in all lease deals to work on building a relationship rather than take a single-transaction approach, says Schenk. "Owners and tenants want someone they can trust long term." Combine that with a lot of hard work, and watch your buildings fill.