While the work from home trend is firmly embedded in the market, the effects are still evolving. It may take a few more years for these effects to be fully felt.
For example, many tenants are downsizing, and some are giving up brick-and-mortar offices altogether. That said, many tenants have long-term leases (signed before the pandemic) that haven’t yet expired. Those leases will expire over the next three to five years. When they do, it’s certain there will be more space put back on the market. This will compound problems for landlords.
Many landlords who have mortgages coming due are faced with a difficult dilemma. In many cases, the value of the property no longer supports the principal amount of the mortgage. If a landlord wants an extension of the loan, lenders typically require them to inject more equity to pay down the principal balance. If the landlord isn’t willing or able to do that, they may have to hand the keys to the lender in a deed in lieu of foreclosure. While many lenders have foreclosed, there are many more loans coming due in the next two to three years, so the resetting of office values may have a long way to go.
Thomas Koelzer, partner with Tenant Advisors/CORFAC International
When lenders foreclose, most don’t want to carry the properties on their books and will often sell the assets at a steep discount. Investors who buy at such a low basis are then in a position to make needed improvements and still offer aggressive, below-market rental rates. This phenomenon will eventually force the rest of the market to drop their rates to the new market levels.
Some properties were struggling before the pandemic, and now the land on which these buildings sit is worth more than the buildings themselves. These properties are being repurposed when possible, or simply demolished to make way for another use.
What does all of this mean for tenants? The most common response we’ve seen has been a hybrid model, where employees are required to be in the office a certain number of days a week while the rest they can spend working remote. With this arrangement, tenants find they can reduce their footprint and still function well.
When tenants downsize, many are electing to “trade up” to a nicer building, the so-called “flight to quality.” Often a tenant can do this with no increase in occupancy cost, thanks to the smaller footprint. Many tenants feel that being in a nicer property is a way to attract employees back to the office.
In conclusion, the market is now decidedly in favor of the tenant. Landlords, while trying to keep their asking rates (or “face rates”) at pre-pandemic levels, are sweetening their deals with above standard rent abatement, higher tenant improvement allowances, and various non-financial concessions (signage, options to terminate, expand, contract, etc.) In the next one to two years, we believe that face rates will begin to soften and drop down as well. It’s a good time to be a tenant!
Thomas G. Koelzer is partner with Schaumburg, Illinois-based Tenant Advisors/CORFAC International.
