COVER STORY, SEPTEMBER 2009

THE CONCESSION STAND
Tenants take a stubborn approach toward incentives.
Jon Ross

A few months ago, Peter Barr of  Haymaker/Bean Commercial Real Estate’s Lexington, Kentucky, office was enlisted to help a law firm move to downtown Lexington. The tenant had its sights on a Class A space being offered at a few dollars less than the market rate, but the firm still wanted more before it made a commitment. In the end, the tenant snagged the space after the landlord tacked on an additional $3 per square foot of tenant improvements and one month of free rent.

“It was fairly aggressive,” Barr says of the deal. “It’s not as aggressive as I’ve seen in some markets, but you’ve got to get creative or aggressive — one or the other; sometimes they work hand in hand.” Many of the leases he’s seen in Lexington are heavily laden with concessions to sate deal-hunting tenants. According to Barr, to envision the typical deal during a time when deals are far from typical, “take the average rents of a building, lower that by 20 percent, take the TIs and add another $5 a square foot and throw in some free rent.”

All across the Southeast, landlords and brokers are trying to keep office space occupied while also bringing new tenants to vacant buildings. Companies looking for office property are also looking for a deal, so this usually means landlords have no choice but to offer loads of discounts to secure old tenants and find new firms. According to brokers in Lexington; Orlando, Florida; and Raleigh, N.C., the promise of posh office living or LEED-certified spaces is no longer enough. In the current market, it’s all about saving money.

“The bottom line is today’s main factor,” says Hillman C. Duncan of Colliers Pinkard’s Raleigh office. He says tenants won’t move on a deal unless significant concession packages are thrown into the mix. In Raleigh, these incentives include free rent and moving allowances, but landlords elsewhere have gotten more creative. Landlords in Orlando have even offered $250 weekly bar tabs to some companies. “You’re talking a $7,000 to $10,000 alcohol tab to keep a tenant happy, which some of our clients see as a value,” says Jason Schrago of CNL Commercial Real Estate in Orlando. “There’s free parking, there’s alcohol tabs, there’s gym memberships — really there’s nothing that is safe right now in negotiations.” 

The main concern for landlords is maintaining a building’s occupancy amid collapsing companies and financial fallout. Brokers have mainly focused on retaining clients and keeping tenants happy, but it’s not impossible to find new users. “There are a few companies coming to the area, which is always a good thing, so everybody’s not competing for the same lease and the same company that’s already in the marketplace,” Duncan says.

Existing tenants are also shopping around to multiple office spaces to try to find the best deal. Landlords have to be wary, however; tenants that have no intention of moving could be testing the waters just to set up a favorable early renewal. “The new tenants … may be leveraging market conditions, but it’s still unknown whether they’ll actually pay the expenses to move and relocate to a different building in the same submarket,” Duncan says. Subleases have become popular with companies that are simply trying to ride out the storm. Shorter leases are a safe bet in this volatile economy, but with many landlords not interested in short-term deals, subleasing is a viable option. “The sublease spaces will cater to a company’s needs. It allows them to get through the next 18- to 24-month time period,” Duncan says.

Concession is not the name of the game for every tenant. Even when discounted rent and other freebies are being thrown at users, companies also have to pay attention to a landlord’s stability. It’s common knowledge that the commercial real estate industry is having a tough time, and lessors of office space know that all too well. “An ownership group with stability is extremely important in these times. The ones that have near-term debt issues or potentially small or local owners are more at risk to try to secure new tenants,” Schrago says. “Some landlords are not offering tenant improvement dollars; they’d rather drop your rate because they don’t have the capital to spend.”

The current troubles in the office leasing market coincided with the collapse of the nation’s economy. At CNL Commercial, brokers started seeing fewer leases more than 2 years ago, a trend that simply accelerated through 2008 and 2009. CNL’s Alex Rosario recently signed two deals totaling 10,000 square feet in the span of 45 days, but he says the market is still grim. “While activity hasn’t really picked up, we’ve just been able to capture some key tenants,” Rosario says.

The bottom came to Raleigh during the middle of 2008. Back then, Duncan’s clients were looking to the next few years and contemplating how much to tighten their belts. “As they were doing ‘09 and further projections, they started recognizing the previous growth modes had plateaued, and now they were in either stabilizing holding patterns or positioning themselves to give back space in efforts to trim and cut costs.”

Lexington’s main issue is the office condo market, which has a 30 to 40 percent vacancy rate. During the years of rampant development, these buildings were constructed on a speculative basis. As they sat empty, the overall suburban and downtown office markets started to feel the effects. Leasing in Lexington has looked grim for the past 5 years, but the recession has made things worse. “It’s gotten more challenging lately because the general movement in the economy,” Barr says. “There’s some renewals that you can do and some downsizes, but there’s just not a whole lot of people willing to make business decisions.”

Employment growth and a general rebound of the financial markets will help re-invigorate the office leasing arena. Brokers in the Southeast think this won’t happen for at least the next year and that real estate will gain stability only in 2011. Landlords who can’t wait that long need to remember, as Schrago says, real estate is on a 10-year cycle. The market will certainly bounce back, and in a few years, landlords will be the ones calling the shots. “This just happens to be the 1 to 3 years that the tenant has the benefit.”

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