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November 2009 |
Miller, Rubenstein,
Hoffman & Hawkinson
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Recession's depth, unemployment result in more concessions
 The stock market may be up from earlier in the year, but
unemployment remains a serious detriment to the overall health of our economy. As a result, the commercial real estate industry, primarily landlords, are having to push incentives to almost undocumented limits to attract tenants who now
have a vast array of extremely affordable options. In turn, as evidence of increasing concessions shows up in office leases around the country, so does the certainty of a slow recovery.
Since the fall of 2007, America watched the stock market tumble, convincing most of us that by it goes our economy. Now that the "markets" have rebounded (to an extent), we are learning that Wall Street, in fact, may not be the best
barometer of strength for many sectors of the economy. For the office building owners, for example, it's employment numbers that pave a direct path to profitability.
For tenants, the downturn has presented countless opportunities to secure office space at exceptional discounts, often in the form of "blend and extends," a term used when tenants agree to an early extension of their lease term in exchange
for lower rent and other concessions kicking in prematurely.
Landlords with first generation space are having to compete with a battered economy, and a flood of discounted sublease space as a result of staff reductions and business closings.
In many cases, a relocation may offer more savings than a blend and extend because falling real estate values have drastically lowered rates for new leases. A major landlord in New York reported that new tenants are paying, on average, 17
percent less for space than current tenants. In Manhattan, average rents have dropped from $66.78 per foot to $47.31.
Nationwide, rents dropped 8.5 percent from this time in 2008. Many landlords, recognizing the slow employment growth, are adding on an additional month or two of abated rent. According to commercial real estate data company Reis, Inc.,
tenants have given back 19.6 million square feet of space, a number to which every landlord is paying close attention.
For healthy companies facing location decisions, there is little doubt that the time is now to lock down space at seriously low rates.
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Tenants still need market stability
 According to Deutsche Bank, losses on commercial real estate
loans provided by banks this year could be close $300 billion as more office properties enter foreclosure, and loan agreements on unfinished developments remain in limbo.
Thankfully, the FDIC has recently gone on record in support of an effort to cooperatively restructure troubled commercial mortgages, an announcement that provides much needed relief to those who envisioned a slew of additional lender
collapses in 2010 because of the increasing weight of unpaid commercial property loans.
For the companies occupying thousands of struggling office addresses, the financial burden of their landlords has created a leasing market so upside down that tenants are now asking property owners for proof of financial stability. While
prospective tenants and their brokers used to take this as a given, it is now necessary to do the diligence to ensure that a landlord has the resources to fund tenant improvement allowances and properly maintain a property in a
professional manner.
Typical market fluctuation is a healthy component of the real estate industry, but volatile swings--from unreasonably high rental rates to today's highly historically low pricing and concessions--can wreak havoc on local economies.
Buildings that plummet in value soon reflect the impact physically, deterring tenants from renewing and discouraging new leases. Furthermore, the side-effects of one empty building can literally spread to surrounding properties. Over
time, submarkets can suffer.
Tenants always benefit from paying fewer dollars per square foot, but at what cost should they sacrifice on service or upgrades that a healthy landlord could typically provide? Reduced building staff, outstanding repairs and the
postponement of aesthetic upgrades are just some of the downfalls that could come as a result of occupying space from a financially-challenged landlord. The more unstable a landlord, the more unstable the tenants' occupancy. In short,
tenants should strive to find a balance between cost and quality.
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Green leases
 Given the current tenant-friendly leasing environment and
increasing number of case studies in support of environmentally friendly office improvements, today's market offers an opportunity for tenants to insert useful lease language that commits landlords to green initiatives.
As many of the current success stories have demonstrated, realizing a return on green improvements requires striking a sound balance between landlord and tenant. For example, landlords striving to preserve occupancy may be willing to sign
a green-centric lease in exchange for long-term renewals or slightly higher rent. In turn, stronger leases could help landlords justify the expense and/or secure the financing needed to implement the changes.
Tenants should be prepared for lease language that covers the pass-through of slightly above-average costs associated with green renovations, provided that they have a positive impact on their occupancy. However, tenants should be wary of
agreeing to pass-through expenses emanating from the process and certification efforts it takes for a landlord to achieve vague stamps of approval or esoteric energy-saving designations. If the benefit constitutes a marketing effort for
the property and doesn't directly enhance a tenant's occupancy of the space, its costs should be 100% paid by the landlord.
Tenants should also make make certain that their lease's "alterations" clause includes the right to use sustainable, recycled or other forms of green materials. It is not uncommon for these sort of materials to be non-traditional or
somewhat obscure. In this case, the landlord should not be able to comprehensively dictate in the lease the type or quality of materials used if they do not live up to today's green standards.
Tenants should also consider proposing rules and regulations language that refers to building operations, such as time constraints on heating and cooling systems, building recycling programs and common area initiatives that help save money
and reflect a dedication to the environment. Or, if a landlord exercises its right to "change them at any time" and does so as part of a energy-saving effort, a tenant should ensure that the lease allows for a grace period for adoption of
the new rules and that occasional minor violations do not trigger a violation of the lease.
These often complicated lease terms should always be subject to the experienced insight of a tenant representative, who can look out for your interests during negotiations and just as importantly, throughout the entire term of your
occupancy.
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