Leasing Pros Share Their Top Tips for Securing Tenants in Today's Market.
Experts agree: Tenants rule the commercial real estate market. Occupancies across all property types either continue to slide or are stagnant, and many brokers don't expect relief until next year. “Now is a great time to be a tenant,” says Charles S. Neil, CCIM, a broker with Grubb & Ellis Bissell Patrick in Charlotte, N.C.
Surprisingly, landlords are holding their own, and rents, while soft, aren't plummeting as one would expect in such a slow leasing market. “Dropping the lease rate doesn't manufacture demand,” says David Murphy, MAI, vice president of CB Richard Ellis in Orlando, Fla. “Only when a tenant shows interest will a landlord start to get aggressive in rates and terms.”
“One thing benefiting owners with vacancies is the low interest rates,” says John “Dede” Malmo Jr., CCIM, president of Malmo Memphis Real Estate in Memphis, Tenn. “They are able to refinance, but tenants will not be seeing cost savings because rents are not going down.”
Although recovery lurks on the horizon, landlords still must struggle through the near term. Thus, Commercial Investment Real Estate asked top leasing experts to comment on today's leasing environment and share their strategies for filling vacant space and negotiating leases that benefit both tenants and landlords.
In low interest- and rental-rate environments, tenants typically prefer to sign long-term leases to lock in favorable terms. Yet in times of economic uncertainty, many tenants are more cautious and uncomfortable with long-term leases, says Daniel J. Tichio Jr., CCIM, vice president of Impact Realty Associates in Hackensack, N.J.
“While established companies want longer leases to get better incentives, small companies that are nervous about future growth do shorter leases,” says Craig Melby, CCIM, SIOR, owner of the Melby Group in Stuart, Fla. Short-term leases also are ideal for companies entering new markets and service companies such as insurance, mortgage, and utilities companies, Tichio says. Retailers also are more interested in short-term leases than office users because “they can go in and out of business at the drop of a hat,” Malmo says.
These days landlords also prefer short-term leases because they are offering more-aggressive terms in hopes that the economy improves soon, says David A. Morris, CCIM, SIOR, a principal and vice president at Colliers Turley Martin Tucker in St. Louis.
“Landlords, especially value-driven ones, are recognizing the upside potential of short-term leases,” Murphy says. Hesitant landlords should ask themselves if they want to lock in a low rate for the long term or do a short-term lease to get through the present. Thus, landlords “get occupancy but can still participate in a market rebound in a few years,” he says. “You don't want to get stuck with a low rate or a lot of concessions.”
“Short-term leases are good if the market remains soft, but no one is anticipating that,” Neil says. The obvious disadvantage of short-term leases for tenants is that rates may be substantially higher when the lease expires. To counter this, Melby suggests including options that increase the rental rate incrementally at the end of the lease instead of all at once.
But there is a downside for landlords as well. The tenant can move at the end of the lease or possibly negotiate an even lower rate if rates remain depressed, says Quentin D. Dastugue, CCIM, chief executive officer of Property One in New Orleans. However, short-term leases raise occupancy, cover cash flow, and pay for operating expenses, so a landlord must carefully weigh the pros and cons, he says.
Since landlords hesitate to compromise rental rates, they are building more flexibility into their leases. “Landlords are trying to make fair deals to keep their buildings full,” Melby says.
Yet the level of flexibility a tenant commands relates to its creditworthiness. “Landlords are still concerned about risk,” Morris says. They might offer aggressive terms, but their tolerance for risk is not high. “Landlords need to protect themselves.” He suggests landlords require higher security deposits, letters of credit for tenant improvement allowances, or several months rent upfront if a tenant has less-than-perfect credit.
Most flexibility issues revolve around space needs. “Landlords should recog-nize that major [credit] tenants have rights such as options to renew, expand, contract, or terminate,” says Steven J. Kaufman, CCIM, director of real estate for Siemens Corp. in Livingston, N.J.
Due to the uncertain economy, more tenants desire kick-out, or termination, clauses specifying under what circumstances they can end the lease and what penalty they will incur. “Cancellation clauses are almost de rigueur now, and many times they will sway where the tenant goes,” says Eric F. Rosekrans, CCIM, CPM, senior vice president of CB Richard Ellis in East Lansing, Mich.
Tenants also are placing more emphasis on buyout clauses at reasonable rates, Neil says. However, very few landlords in a down market allow buyouts that aren't guaranteed in a lease. “A landlord's No. 1 goal is value and occupancy of the property, and few are willing to give up occupancy,” for the quick cash infusion from a buyout, Murphy says.
On the other hand, Melby is seeing more high-credit tenants ask for expansion clauses, in which the landlord provides them with additional space if needed or lets the company out of the lease with no penalty.
Brokers also can negotiate flexibility in tenant expenses not related to rent. Tichio tries to get certain operating expenses excluded from his client's leases, such as marketing costs, capital improvements, and administrative expenses. He suggests auditing the landlord's books at least once a year to “find items [your client] should not have to pay for. It keeps landlords on their toes,” he says.
Malmo has been successful negotiating reduced limits for general liability in insurance clauses. He also tries to decrease his clients' liability, such as lower security deposits or waived personal guarantees.
However, “it's important for landlords not to give away the house,” which is why a broker's expertise is essential, Murphy says. “Good tenant brokers are able to provide more flexibility because landlords are more willing to agree to [these terms] than in the past,” he says.
Landlords also are offering incentives to sign tenants in their buildings. For example, some Florida tenants receive free and discounted rent and TI allowances: “The normal items on the table — tenants just get more of them in soft markets,” Melby says. In a typical five-year lease in St. Louis, tenants may receive two months to four months free rent, a higher TI allowance, and other perks such as subsidized parking, Morris says. Neil is encountering more landlords willing to do turnkey buildouts, or customizing space to a tenant's specifications instead of offering a lump TI allowance.
In addition to offering tenants incentives in their leases, landlords also are wooing tenant representatives to get their space noticed. “Landlords really want to incentivize tenant representatives in fee sharing or commission because they don't want to be left behind,” Melby says.
Beyond higher commissions, landlords sometimes go to great lengths to attract tenant brokers. In New Orleans, landlords have offered Lamborghini leases to brokers whose large credit tenants rent space, although “I don't know how well that works,” Dastugue says.
In fact, offering cooperating broker incentives raises some ethical eyebrows. “Most brokers won't show space that doesn't meet their clients needs” simply to procure a chance to win an incentive, Neil says. Murphy agrees: “Good brokers won't be influenced. Incentives help properties get noticed, not leased.”
If all else fails, landlords should reposition or do something else with their vacant space until the economy rebounds. “In such a market, there is a blurring of the distinct characteristics of property types, such as retail becoming office service,” Kaufman says.
For example, Tichio marketed a warehouse in northern New Jersey as an exercise facility. “It's easy to find creative uses for flex space,” he says. Another creative use is leasing space to television and movie production companies for filming, says Susan Fowler McNally, JD, an attorney with Gilchrist & Rutter in Santa Monica, Calif. (Learn how to negotiate leases with production companies in the sidebar “Starring: Your Building.”)
Yet at the end of the day, both tenants and landlords still are motivated by the economics of a deal, not creative perks and incentives. Tenants may have the edge, but both sides are struggling. “Everyone is focusing on economics — what can we do to make this lease work?” Rosekrans says.
“The lease with the lowest total present value will win,” Murphy agrees. It's up to the skilled broker to procure such a lease for his client.