Lease Negotiations in Today’s Office Market
The Houston office market has shown a recent trend of “negative absorption” That means that more space is becoming available than is being leased or purchased. As a result, the law of supply and demand is helping to cut rental rates and creating incentives for building owners to offer tenants additional concessions. Since the beginning of 2009 the Houston office market has recorded 3,188,507 square feet of negative absorption, while the overall vacancy rate has increased from 13.5% to 16.5%.
Houston Office Market (Historical Net Absorption)
This has CFO’s and corporate real estate managers looking for their opportunity to lock-in better long and short-term lease deals. However, better does not necessarily mean significantly lower rental rates. Since the downturn in the Houston office sector began in the first quarter of 2009, the erosion of rental values at least in terms of quoted rents has not been all that severe. Average quoted rents for Class A space in the Central Business District are off 6.6% and just 1.9% for suburban Class A office projects.
Houston Office Market (Class A Rental Rates)
I should note there is a difference between quoted rents and the final negotiated rental rates. The gap between initial quoted rents and where deals are getting signed is certainly bigger than it was 18 months ago. In fact one of the first indicators the office market is improving will be when we begin to see substantial compression in the gap between quoted and actual rental rates.
The bigger difference today in terms of the overall flexibility in the latitude of negotiations by building owners is reflected in other leasing incentives such as:
- Free Rent
- Tenant Improvement Allowances
- Abated Parking Charges
Particularly for tenants with solid credit, a Landlord is much more willing to offer attractive incentives that don’t diminish the face rental rate as severely, which helps preserve the future market value of the asset. This is trade off for the Landlord, up-front free rent periods and liberal tenant improvement allowances impact the building cash flow today, but maintains a higher cash flow later in the lease when the building owner is more likely to sell or refinance the asset.
For the Houston office tenant who is more concerned about the overall occupancy cost of the lease, the opportunity to negotiate more free rent, abated parking charges, as well as tenant improvement allowances that provide for a turn-key buildout or upgraded premises rather than focusing too much on the rental rate, is the effective negotiation today. Depending on when you signed your last lease, you might expect a lower rental rate, but the real cost saving opportunity is the other concessions. I should note that some landlords are not in a cash surplus position, so a big tenant workletter is difficult to obtain. In these cases the concession to focus on should be on free rent.
Locking in Long-term
Companies who are comfortable making a longer term commitment also have the opportunity to lock into lower rates for a longer term. In todays market conditions building owners are more willing to fix face rental rates for either a longer period or with less severe rental adjustments throughout the lease term.
Credible Market Evaluation
The critical component of any successful negotiation strategy includes a credible market evaluation. In a market where leasing activity is down, creating stiff competition for your tenancy may yield some very attractive and surprising results. Houston has survived the recession in much better condition than many major office markets around the country as evidenced in our rental values, yet a real opportunity does exist to get much “More for the Money”.
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