Commercial Real Estate: IN Focus

Office Market Gloom = Silver Lining for Tenants

Until recently, most New York City office tenants held little bargaining power. Landlords not only achieved their asking rents, but some even watched as their future tenants faced off for the right space—and drove the effective rents through the roof.

by Peter Shakalis

Times have changed dramatically since those days. Tenants wield considerable clout in the current office market, and landlords are in most cases anxious to work through terms with them. The question is: How can tenants effectively use this market to their advantage? The savviest tenants understand that the best deals only come to those who work with an experienced tenant representative.

So just how weak is the New York City office market, then? In Manhattan the overall availability rate for office space at the end of 2008 was 10.9%, the highest level in two years. Overall asking rent for Manhattan dropped by 4.0% from the previous quarter with leasing activity down 18.4% below the pace of a year ago.

When landlords lose their tenants in a market like this, they face substantial costs to replace them. Their costs often include a year or more of lost revenue due to vacancy, the cost to reconstruct a space for a new tenant coming into the building which can cost upwards of $80.00 per square foot ($8.00 per square foot over a 10 year lease), another 6 to 10 months of free rent to induce the tenant to sign a lease, as well as the landlord's marketing costs.

Against this backdrop, landlords have become increasingly aggressive in their tenant retention programs, putting tenants in an excellent position to maximize their negotiating leverage with their landlord particularly if the landlord is under the perception that the tenant is prepared to move to a less expensive or better quality building.

Companies paying rents higher than the present market--and which have leases coming due over the next one to three years--should consider proposing a rent reduction in their present lease, in return for a long term or extended commitment to stay in the landlords building. The difference between the tenant's present rent and the new reduced rent would be allocated over the new extended term, resulting in both an immediate rent reduction and a new long term lease.

Consider a tenant that is leasing 10,000 square feet of office space and pays $90 per square foot. Let’s assume that our hypothetical tenant has two more years remaining on their lease. The tenant hires an agent that would negotiate a new 10-year lease renewal at a reduced rental in the building. That lower rate would be $75.00 per square foot.

The differential of $15.00 per square foot for the two remaining years (or $150,000) would be spread out over the term of the new ten-year lease, resulting in an additional $1.50 per square foot per year for a total of $76.50 over the new term.

Both landlords and tenants, however, should be mindful of the other’s financial position. Tenants need to consider a landlord’s staying power in these difficult economic times – especially for many of those properties that were purchased during the last several years at top dollar. Similarly, with business conditions deteriorating for many firms, landlords need to be vigilant about tracking the financial stability of their tenants.

The coming year will be one of great changes–both expected and unexpected. Change, however, always brings opportunities for those who are attentive and can react quickly and decisively.

Peter Shakalis is a Director at
FirstService Williams Real Estate
pshakalis@fswre.com

©2009 NEOCORP MEDIA

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