Owners, Brokers Being Creative in Complicated Market

The impact of the economic crash and the slow march toward recovery have forced brokers and office building owners to be flexible and creative in negotiating deals with tenants. Brokers are reporting increased leasing activity in the office market, but often it is from tenants hoping to renew early so they can decrease the amount of space they are leasing and negotiate lower lease rates. “You have a lot of people doing a blend and extend,” said Mike Tingus, president of Lee & Associates-LA North/Ventura Inc. “When tenants have one year left on their lease, they are signing a five-year lease at a lower rate and reducing their space.” Depending on the amount of space the tenant wanted to give back on renewal or where it was located, landlords have had to make some tough decisions. In some cases, it was easier to move the tenant to a different space in the building, rather than divide a space, which can bring additional costs, Tingus said. Smaller office building owners have given up tenants rather than reduce rates to a level that would not support the mortgage on the building, he said. “Some landlords can afford to reduce rates and some can’t,” Tingus said. “The mom and pops can’t. If you have a 20,000-square-foot office building that you are getting $10,000 a month for, you can’t afford to lose $5,000 of that or all of a sudden you are in a situation where the cash flow on the building is out of whack and you can’t afford the mortgage payment.” The concessions and tenant improvements that landlords are offering vary widely. In some cases, Tingus said, tenants are receiving no free rent, in others they are receiving 10 months free rent on a 10-year lease. The tenant improvement allowances landlords are offering for tenants to adapt their interior office space can range from $5 per square foot to as much as $80 per square foot, he said. Most office building owners are focused on tenant retention, because they don’t know how long it might take to replace the tenant and new tenants usually result in higher tenant improvement costs, said David Solomon, a senior vice president in the Universal City office of CB Richard Ellis. “Down time and tenant improvements are real cash flow factors,” Solomon said. “Landlords have to consider if they lose a tenant just how long it will take to fill the space.” Larger concessions That concern is resulting in landlords making larger concessions, which may include free parking or converting unused tenant improvement allowances to free rent or an offer to freshen up the space, he said. “In difficult times, you see blend and extend where the landlord recasts or reduces the current lease to keep the tenant,” Solomon said. Early lease renewals can be a money-losing proposition for landlords, Solomon said, because concessions such as free rent or tenant improvements are usually frontloaded in lease agreements. Typically, five months free rent would come at the beginning of a lease, so the tenant is paying a higher rent toward the end because the concessions have burned off, he said. The lease might appear to be over market to the tenant just because the concessions have burned off, he said. Another economic sign of the times, is that both the landlords and the tenants are doing greater due diligence before a lease signing, Solomon said. The landlord wants to insure the tenant can fulfill the lease terms and the tenants are asking for non-disturbance agreements, so that if the landlord sells the building, the lease agreement will still be honored and the tenant will not be evicted. Considering the general state of the economy, Solomon said he is not surprised when the owner of an accounting firm renews, but gives back 1,000 square feet. “The general consensus is that it feels like the bottom of the office market,” Solomon said. Longer lease terms A change that is indicative of the market hitting the bottom is that tenants have begun to try and negotiate for longer lease terms – and that wasn’t the case a year ago when tenants wanted shorter lease terms and landlords were pushing for longer terms. The situation has flipped with tenants realizing lease rates might not get lower and landlords not wanting to lock in the low lease rates for the long term. Tom Dwyer, a senior vice president in the Camarillo office of CB Richard Ellis, said he has seen an increase in activity. “In the Conejo Valley, we are tracking 56 companies actively looking for office space above 5,000 square feet,” Dwyer said. “Some of them are looking to leave the city of Los Angeles to be relieved of the gross receipts tax.” To Richard Pearson, a principal in the Woodland Hills office of tenant brokerage CresaPartners, the office market appears to be “fairly stagnant.” “We represent tenants and the ability to negotiate long term leases has been and is there,” Pearson said. “We have landlords who are eager to attract tenants to their buildings.” Pearson referred to the talk of increased activity as phantom activity. “Every time a tenant has a lease expiration coming up they look at other space even though they are just looking to renew,” Pearson said. “Sometimes when this happens, landlords think there is lots of activity.” While his clients see this as an opportune time to strike a deal, Pearson said he advises caution because he doesn’t anticipate lease rates increasing over the next year. “If the business is stable, it’s a no brainer to lock in a long-term lease, but if the business is growing or shrinking, then they shouldn’t do it,” Pearson said. “You do not want to be stuck with too little or too much space.”