Has the commercial real estate market hit bottom?
With the real estate industry showing signs of improvement, now is the time to take advantage of the soft market and recast your lease. “This very well may be the bottom for the commercial real estate market as it relates to lease rates,” says Rick Pifer, vice president of Plante Moran Cresa, a real estate consulting firm in Southfield, Mich. “You are in a leveraged position to use your tenancy to lower lease rates.”
Nearly $50 billion in loans on commercial buildings are coming due within a year, written during the height of the real estate bubble, and your continued long-term tenancy offers strong leverage for the building owner during the refinancing of these loans. Vacancy rates, which climbed rapidly in 2007, have remained level for three years and appear to show signs of decline. The window of opportunity to lock in the most aggressive rates and take advantage of a tenant’s market may be closing in the very near future. We spoke with Pifer about how companies can take advantage of the current real estate climate to lock into a better lease, before it is too late.
Why is now the best time to consider a recast?
Commercial building loans are typically in duration for five-, seven-, or 10-year terms. As loans are coming due, building owners are in a position where they are forced to refinance, so the length of term remaining on your lease is more valuable than the lease rate itself.
A landlord ideally wants 95 to 100 percent occupancy at all times. Vacancies cost a lot of money in operating expenses and lost rent, and securing new tenants adds to that bill.
The high rate of vacancies we have seen in the down market has really hurt property owners, and they need to retain tenants. This makes them more willing to negotiate on your lease obligation in exchange for a longer commitment from you.
But rates actually appear to be going up as vacancy decreases. There has been relatively no new construction of speculative office buildings over the last four to five years, and for the first time in that time period, the trend appears to be toward decreased vacancy rates.
As a result, we are seeing positive absorption, which means more space was leased in the market than has become available. Lessees need to take advantage of the market before it rebounds.
How many years should a lessee have left on a lease to consider a recast?
As long as you are more than halfway through the term or have less than four years remaining on the lease, you should consider a recast. It may not always make sense to do it, but it is something that should at least be evaluated as a potential cash flow relief.
What other determining factors should a lessee look at when considering a recast?
One of the main components is the building and location. Do they make sense from a long-term, strategic position? If the answer is yes, then locking in today’s market makes a lot of sense strategically and financially.
You are looking at making a commitment of time to a building. If the building works for your organization and you do not have any reservations about making a long-term commitment to the building, then recasting the lease makes sense.
Should a lessee approach the landlord directly to renegotiate?
No. One of the key components in renegotiating is utilizing a tenant-only representative, someone who has no independence issues as it relates to representing the landlord. The representative advocates solely on behalf of the tenant’s interests and has a fiduciary responsibility only to the tenant.
Tenants sometimes feel that they are in a position to approach the landlord directly, but what they overlook is the fact that the landlord is a real estate professional. Handling real estate transactions is what they do day in and day out, which has helped them be successful as a landlord. A lot of leverage can be obtained with market knowledge, which may not be readily accessible to those who are not working in the real estate profession on a daily basis.
Also, if a tenant approaches a landlord directly, the seriousness of the intent is a hard message to deliver. It is similar to telling someone you are going to sue them. It is more effective if an attorney sends a letter than you saying you are going to do it. If someone hires the services of a tenant-only representative, the landlord understands the seriousness of the intent of the tenant.
Additionally, there is always the opportunity to re-evaluate space utilization in making sure that the space is working and is optimized for the business. Look for a tenant-only representative who can take a strategic approach in looking at all facets of the real estate instead of just looking at the lease rate. It is important to evaluate all of the components of the lease and align the space to the strategic business plan from a real estate perspective.
That will allow you to get a strategic real estate decision that allows you to optimize your tenancy to leverage the best deal the market will offer. In addition to a lower lease rate, you may be able to negotiate for a rent abatement provision, more flexible cancelation provisions, lowered operating expenses and updates to the space’s interior.
RICK PIFER is vice president of Plante Moran Cresa, a real estate consulting firm based in Southfield, Mich. Reach him at (248) 223-3698 or firstname.lastname@example.org.