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Renew or Relocate? Incumbent Landlords Willing To Sweeten the Pot

Mark Heschmeyer, CoStar Group (Winter 2012)
While perhaps not a nationally significant or unusual deal by itself, U.S. Cellular's renewal this past month of an office lease in Madison, WI, succinctly depicts the current state of leasing.

U.S. Cellular agreed to extend its lease with affiliates of Wells Real Estate at the U.S. Cellular Building, a four-story, 102,000-rentable-square-foot office building. The Chicago-based carrier leases 73% of the building and owns a 45% equity interest in the property. The amendment extends the lease from April 2013 to December 2017. As part of the deal, the monthly base rent will decrease 11% from $87,668 to $77,830. In addition, U.S. Cellular is entitled to a four-month rental abatement.

Several things about this deal make it typical of other firms making lease renewal decisions in the current market. Landlords have a vested interest in holding onto quality paying tenants, or risk loss of income, more scrutiny from current and potential lenders, and face higher marketing costs to re-fill the space.

Tenants, too, have a vested interested in staying put. While in this case, the tenant is part owner, in other cases, tenants face a disruption in their business and significant relocation and operational costs if they leave a good location. But the market reality is that there are good deals to be had out there as vacancies remain stubbornly high and money for refinancing commercial properties remains hard to come by. As a result, tenants are clearly making the decision to at least shop around.

"In sectors like the office market, we're finding tenants taking the opportunity in a soft market to upgrade office image and pick-up additional amenities by moving from a Class B building to a Class A building, generally with minimal increases in their rent. The term you hear tossed around is 'flight to quality,' " said Ryan Walsh, principal of RadatzWalsh Inc. in Edina, MN.

"To compete with the market, landlords are offering up free rent to keep tenants, somewhere around one month per year of the lease, (net or gross) depending on the situation and other terms," Walsh said. "Also, improvement money is being spent to upgrade finishes and make spaces more functional on extensions. Usually $10 to $20/square foot for 3- to 5-year deals and some additional credits or rent reductions if the space can be used as is."

"It is all on a case-by-case basis," Walsh said, "but the savvy landlords factor in the costs of having the space sit vacant for a while, tenant improvements for new groups and other transactions costs. They generally come to the conclusion that it is in their best interest to work hard to keep a good tenant that they know pays rent on time."

Nelson Taylor, owner/broker of William Raveis Chapman Enstone in Providence, RI, said tenants are also leveraging the market to cut a better deal for themselves.

"Many will approach their current landlords for lease/term reductions," Taylor said. "Tenants will approach me to give them comps to support their requests. More often than not, if their requests are reasonable, owners will agree to a reduction. If owners prove inflexible, tenants will move."

"Owners are much more flexible with 3- to 5-year leases. In my world of crossover commercial, most owners are reluctant to do anything over five years, though they will offer renewal options. At least 10% reductions in the overall lease costs," Taylor said.

While U.S. Cellular merely extended its current lease, CoStar is also seeing landlords offering concessions to tenants who renew -- even if they are downsizing. Case in point, AeroGrow International Inc. amended its lease with Pawnee Properties LLC in November 2011 for its headquarters at 6075 Longbow Drive in Boulder, CO.

AeroGrow renewed its lease but reduced its square footage from 16,184 to 9,868. The landlord reduced the monthly base rent 23% to $9,046 ($0.92/square foot/month) from $19,261 ($1.19/square foot/month). The lease was extended 18 months to September 2014.

"My experience is that all my clients are reassessing their space needs, consolidating as necessary, removing redundancy and heavily incorporating hi tech where it can," said Guy Levingston, principal of Intermountain Commercial Real Estate in Boise, ID. "They will shop the market and present competitive bids back to landlord to see if the landlord will budge or meet the best deal. You call it landlord generosity; I call it "market rate" for 2012. I believe it is going to take some years for office market rental rates to climb back up to what was considered "normal" before the 2007 downturn."

Kevin Postal, president/broker of Atlantic Property Group in Port St. Lucie, FL, agreed, adding that such short-term concessions provide a way for the landlord to ride out the down market.

"Most landlords don't want to sign leases longer than three years at the lower rate hoping that there is light at the end of the tunnel for better returns on their investments," Postal said. "It is definitely a buyer's market, but landlords usually won't show their hand until it's absolutely necessary. I've seen reductions up to 30% in some office rents."

"Although most tenants prefer to stay in existing locations, they are also economy-minded these days," Postal said. "Of course, they want to seek out the best deal in the market. I am finding that tenants are willing to move as far as 15 to 25 miles in any direction if it means saving money."

Many tenants are also taking advantage of current conditions to expand at their current location while signing on for a lease extension.

REVA Medical Inc. did just that for its corporate headquarters at 5751 Copley Drive in San Diego. REVA more than doubled in size, expanding from 17,018 square feet to 37,470 square feet under a new deal with landlord ARI Commercial Properties that extends its lease through January 2018. Under the terms of the lease amendment, the annual base rent for the leased space increases over the term from $37,000/month (80 cents/square foot) to $60,000/month ($1.60/square foot) at the end of the lease. Up until the amendment, REVA Medical had been currently scheduled to pay $1.60/square foot per month.

"Many landlords have offered reduced rates to blend-and-extend for three to five additional years. I don't view this as landlords being generous but rather (they are) being strategic to lock-in longer lease terms, stagger expirations, and reduce capital expenditures," said Steve Rosetta, executive vice president | market leader, Cushman & Wakefield of San Diego.

"We are seeing tenants shop around for better terms and more flexibility versus renewing," Rosetta said. "In the end, a tenant may renew but they are all testing the market. Landlords may be reluctant to drop rates to keep a tenant initially but nearly all will reduce rates rather than loose a tenant to another building."

NetSuite Inc., which leases 79,589 square feet for its corporate headquarters at 2955 Campus Drive in San Mateo, CA, extended its lease in December for another seven years until August 2019. In 2010, NetSuite had already amended its original lease signed in 2008 to reduce its space to its current size. With the extension just signed, NetSuite will be paying $40.20/square foot per year in 2013. Under its original 2008 lease, NetSuite had been scheduled to pay $63.88/square foot per year this year. So by extending long term, NetSuite has cut its scheduled rent more than a third.

"At the beginning of a process, a [tenant] client may feel they will renew or give back space. However, after going through a real estate process it becomes quite clear what is financially and operationally more favorable," said Michael McKeever, senior vice president, UGL Services Los Angeles. "The smart landlords are offering concessions to maintain occupancy, so the tenant may renew but typically on much better terms than they originally thought. It's case by case. Some clients are reducing their rent by 20% and combined with space give back sometimes 40%+ reduction."


Note: This article originally appeared in CoStar Group Inc.'s newsletter. Comments from other commercial real estate industry professionals about what they are seeing in terms of office renewal negotiating conditions in their markets can be found here.

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