Shrewd Landlords Win in Current Office Market Cycle

05/02/2015

Randy Mercer, News-Press

Despite continued signs of improvement and upward trajectory in Southwest Florida’s office market, inventory still exists across all asset classes. Landlords continue to struggle to determine the magic combination of tenant concessions and rental rate to attract quality tenants and maximize their own asset value.

With vacancy in Lee County’s office market hovering around 24.6% there are plenty options for most mid-sized office tenants. Landlords must remain cognizant of this fact, and act strategically and rapidly if they hope to get their vacant spaces in the game.

The topic of tenant improvements is always a tough pill to swallow for landlords. Immediate thoughts shift to large capital outlays and significant risk that tenants fail to repay amortized portions of build outs—leaving ownership holding the bag for the improvement. As a broker who works extensively in Southwest Florida’s office market, I often caution landlords to employ more tactical deliberation when considering the spectrum of tenant improvement options and their respective benefit to an asset’s bottom line.

“Don’t compromise what you want most, for what you want now” (Zig Ziglar).

The goals of landlords are fairly consistent—fill vacancies, increase cash flow, stabilize asset, and add overall value. Despite this consistency, there are property owners who accomplish this goal in a much more astute fashion than others. Many landlords are hasty and fail to execute on valuable leases for reasons which don’t make long-term financial sense. This occurs often when landlords don’t understand the true cost of their vacancy.

Landlords like to save money—this is a fact. Yet, successfully walking the line between saving money and missing an opportunity to add value to your investment is what separates shrewd investors from average ones. Landlords in high occupancy positions in any market have learned the art of spending money in the right places, at the right time. Rental investment is calculated in two interconnected ways. The first is cash flow (rental income). The second is appreciation in the value of the property. Assets with deferred maintenance will not see appreciation. Well-maintained products pay ownership back –it’s really that simple.

Tip #1: Increase Cash Flow with Short-Term Leases

When demand from “ideal” tenants is shallow, landlords need not remain idle. Considering short-term leases at lower rates to backfill vacancies helps to make an immediate impact to ownership’s cash flow. Further, short-term leases have fewer requirements (if any) for landlord contribution to tenant improvements.

Tip #2: Help Tenants Envision Space Potential

While most corporate entities have a keen understanding of their build out requirements, many local and regional office users are less than certain and may have more difficulty in envisioning the potential in vacant outdated spaces. For very little expense, landlords sitting on multiple vacancies can invest in conceptual space plans to help mitigate this concern. Landlords can help themselves greatly by arming listing brokers with the tools to provide immediate differentiation of their asset amidst a sea of competitive inventory—yielding faster absorption, higher rental rates, and optimal lease terms.

Tip #3: Maximize Renewals

Assuming tenants are in-place at market rents with healthy escalations, a landlord’s prime focus should be on retaining existing tenants. This focus will include offering tenant improvements for renewal users as well. In almost all cases, renewals require far less tenant improvements and are an overall less expense to ownership. Added flexibility is afforded to existing tenants to avoid risking the need release their space—weathering the loss of time and money. It is always cheaper to keep a tenant than to find a new one.

Tip #4: Employ Creativity | Flexibility

Be flexible—always. When you find yourself in the majority (utilizing the same strategies as others), it’s time for a new angle.

1. Allocation for future expansion: Consider allowances for qualified tenants who may want to expand at a later date. Creativity in this arena includes scheduled “step-up rents”—whereby tenant pays on less space for an initial period and takes the balance of the space later in the lease term. Expansion in place is an added value for both tenants and certainly for landlords.

2. Varying control of build out: Toss around the idea of allowing tenants to build out their own spaces. It can be a win-win as tenants benefit from lower initial lease rates, and landlords can defer or eliminate upfront capital expenditure and minimize the need for personal lease guarantees. If landlords do retains control over tenant improvements, make sure contractor timelines are met. Unnecessary deferrals in rent commencement are costly and avoidable.

Landlords, effectively differentiating your asset from your nearest competition is worth its weight in gold. In the wise words of Eli Broad – half of the Fortune 500 Company KB Homes, “The best move you can make in a negotiation is to think of an incentive the other person hasn’t even thought of – and then meet it.” Top performing landlords focus on creating demand rather than responding to it.

Further, both landlords and tenants should refocus and learn to “choose their battles”. Maintain a good understanding of the items which are “vital wins” and where compromises and negotiation should become a pertinent factor.

Winning landlords in the current “transitional” office environment are those who continuously regroup, redefine and react to the new reality.

Randal Mercer is a founding partner for CRE Consultants. He is responsible for commercial property transactions, asset management and investment analysis. His brokerage specialty is office/investment properties.

Serving Fort Myers, Cape Coral, Lehigh Acres, Estero, Bonita Springs, Naples, Marco Island, Port Charlotte, Punta Gorda, Sarasota, Manatee County, Hendry County, Stuart and all of Florida.