Lease arrangements in a 'tenant's market'

“The building is vacant, so why won’t they accept my low offer?”

This is a commonly asked question by prospective tenants who struggle to negotiate a lease for commercial space in a market that everyone agrees is a “tenant’s market.” Tenant decision-makers hear the news reports on increased vacancies and they say, “For lease signs are everywhere.”

What tenants fail to understand is that landlords have a longer time horizon. Furthermore, most landlords have been in the business for many years and have experienced several economic cycles. These landlords are not as desperate as tenants might think. Most landlords who have financing in place also need to receive lender approval for any leases they enter into. Many lenders have underwritten the loan with lease rate assumptions that, if violated, could trigger a revaluation that may create more concerns for both the landlord and the lender. A prolonged vacancy, however, is underwritten as a normal course of economic cycles and does not deteriorate the long-term value assumptions for the property.

In addition to a lease rate, other factors are important to a landlord that some tenants overlook. What is the credit risk of a new tenant and what type of “tenant improvements” and “base building improvements” would the landlord be required to fund?

Commercial properties are more specific to the tenant’s business. A property in “like new” condition usually requires some revisions to meet the needs of the new tenant. In office properties, the offices, conference and cube areas may be suitable, but new carpet and paint are often required. Industrial properties are even more customized for a tenant’s use, as the power distribution and plant layout are important for efficient use by a business. The landlord may be more inclined to wait for an improving economy and a “credit tenant” before investing more capital into a project.

Discounted lease rates are available, but landlords will strategically shorten the lease term as to not lock in the lower lease rates and miss out on the eventual improving economy and tightening supply-and-demand forces. If a tenant can agree to a shorter term and accept the risk of an eventual increase in rent, this is their time to realize some occupancy cost savings and work with their landlord to develop a mutually beneficial lease agreement.

Roger Dieker, vice president and managing broker of the Manchester office of CBRE/New England, can be reached at 603-792-2604 or roger.dieker@cbre-ne.com.