The market for development and acquisition of office properties remains slow. However, owners must still lease their existing product as leases roll over, tenants move and vacancies are created. Since the turbulence of a few years ago seems to have calmed, now is a good time to a step back and review the current environment.
The most common activity we see is variation of “extend and pretend” in the lending market. Office tenants find themselves with more leverage than in prior years (even though many of these tenants do not realize it). Many tenants are finding that they are paying over-market rates, and they have either kick-out options or expiration dates in the near future. This presents an opportunity to the tenant to renegotiate their leases to better their deals, either in terms of reduced rents, reduced space, additional improvements or other incentives. Landlords, not wanting to brave the open market in search of new tenants, are making deals to keep their buildings full. Since this transaction is similar to a work-out of a loan (even though not always precipitated by a defaulting tenant), landlords should consider making concessions contingent upon the tenant remaining in good standing under the lease. Another important quid-pro-quo is reviewing the landlord’s position, and including rights that may serve the landlord well when the market does pick-up, such as relocation rights, parking allocations (discussed below) and changing fixed-price renewals to fair market value renewals.
With reduced occupancies, operating expenses become even more important, since not recouping a tenant’s full pro rata share of operating expenses only compounds the owner’s problem of subsidizing vacant space. The most common problem we see is setting base year expenses too high. Many leases simply provide that a tenant pays its share of operating expenses over the costs in the base year. Consider a base year with heavy snow fall, or an extremely dry summer in which landscaping and irrigation costs are unusually high. The base year lives forever, so it is important to provide that a base year can be adjusted for unusually high expenses. The manner in which those costs are adjusted is a matter of negotiation, but recognizing and dealing with the issue up front is the first, critical step.
Finally, to reduce space costs, tenants are attempting to minimize their space needs, without necessarily reducing the number of occupants. This leads to parking nightmares in under-parked projects. The parking lot is often the first impression made on a prospective tenant. Pulling into a prospective building and finding no parking is a sure way to lose a tenant. Therefore, it is critical for landlords to understand their parking supply and, if necessary, impose the right to allocate parking among tenants. Often, there are entire sections of parking lots not being used because of proximity to entrances/exists. Landlords need to deal with this up front to protect the marketability of their projects.
Even in a down market, it is important to stay ahead of the game. The sun will rise again, hopefully soon, and owners need to be prepared.