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Landlords typically weigh a prospective tenant's credit when they're negotiating a lease.
Now, in a twist that highlights how things have changed in the downturn, it's tenants' turn to scrutinize landlords for fear that lenders might foreclose on their building.
Welcome to the new realities of commercial real estate. Rising vacancies, declining rents and a wave of loans tied to commercial real estate coming due are giving tenants the upper hand in rent negotiations.
The question is, how long will this situation last? If things get worse, tenants may get better opportunities next year. If the economy improves, landlords will regain lost ground. “It's almost like Russian roulette for a tenant,” says
Karen Johnson-Crowther, managing director and principal with Colliers Arnold in Fort Myers.
The answer is unknowable, of course, but much depends on your view of the economy and the role of a possible government bailout in the commercial real estate mortgage business.
For now, tenants rule.
In the Westshore business district of Tampa, the largest office market on the Gulf Coast, the vacancy rate in office buildings was 18% at the end of the second quarter, according to market tracker CoStar Group. For the top-quality “class A” space, 23% was empty. “In Westshore, it was 4% two years ago for class A,” says Jeffrey Feeley, director with Rubin Real Estate in Clearwater who specializes in tenant representation.
Depending on the market and the type of building, rents are down 10% to 40% from their highs in cities from Tampa to Naples, brokers say. In addition, landlords are offering free rent, tenant-improvement concessions and showering brokers with double commissions for those who can bring them deals they can close quickly.
“History repeats itself,” says Feeley, who was in the business through the last commercial real estate recession in the late 1980s when vacancy rates last jumped into the 20% range. “I think we've got some dark days ahead,” he says.
Larry Richey, senior managing director at Cushman & Wakefield of Florida in Tampa, is also a veteran of the last commercial real estate bust. “Despite the wonderful opportunities for tenants, this time around there is a greater resistance because they are afraid of the uncertainty that's occurring in the world economy, the local economy and what the government may or may not do,” he says.
“Tenants are taking 20% less space on average when their leases are renewing,” Richey says. This corporate anxiety cuts across almost all kinds of businesses, he notes.
Compared with the last commercial real estate downturn, oversupply isn't as big a problem because developers were comparatively more restrained this time around. There are pockets that are overbuilt, of course, but not on the same scale.
“There's just no demand,” says David Conn, executive vice president with CB Richard Ellis in Tampa who specializes in retail properties. “Everybody's frozen and that's what's driving us crazy.”
The decline in leasing activity is evident in other areas of the Gulf Coast. Randy Mercer, partner with CB Richard Ellis in Fort Myers, says government's efforts to nationalize health care is affecting the leasing of medical-office space, for example. “That debate has forced everyone to pause,” Mercer says. “We experienced the same situation in 1992 when the Clinton administration was trying to fix health care.”
“Everybody is talking of increased activity levels, but we haven't seen a greater number of deals closing,” says Cheri O'Neil, senior vice president and branch manager with Studley, a tenant-representation firm in Tampa. “Decision-makers leave the country so they can't answer the phone,” she chuckles.
Tenants are scrutinizing landlords for fear that lenders will take buildings back if owners default. “We're hearing real scary stories,” O'Neil says. “Whose notes are going to be called?” The potential problems include deferred maintenance and broken promises of tenant improvements.
But there is evidence that the situation may begin to stabilize and perhaps even reverse. Corporate earnings have improved, albeit on cost-cutting like paring real estate expenses. The stock market rally has given the capital markets renewed hope. And there's talk that the government will bail out commercial property owners and investors who borrowed heavily during the boom.
And in times like these there are growing industries such as education. “These guys come out of the woodwork in every downturn peddling retraining,” Feeley says.
Other industries showing growth include technology and some financial services. “We are seeing mortgage and title insurers, but the view is maybe it's a short-term thing,” says O'Neil. “There's no real depth to those commitments.”
On the retail side, dollar stores, consignment stores, auto parts and liquor stores are among the retailers expanding. “People aren't shopping new,” Johnson-Crowther says.
Job growth is key
The woes in commercial real estate can be traced directly to job losses. For the one-year period ending July 31, the five metro areas of the Gulf Coast from Tampa to Naples lost more than 100,000 jobs, according to the Florida
Agency for Workforce Innovation.
The steepest job-loss declines on an annual-percentage basis have been in the Cape Coral-Fort Myers area.
“What I'm finding is that there is still a good amount of companies that won't be making it,” says Bob Johnston, an industrial-space broker with Grubb & Ellis 1st Commercial in Fort Myers. “They've been trying to survive the recession but they're finding out that it's going to take longer to return to normal.”
The Fort Myers area remains highly dependent on the residential market, with about 60% of the industrial space still catering to homebuilders. “We feel the industrial market won't be coming back until residential comes back, and that's still 24 months away,” Johnston says.
Further north, in the Tampa Bay area, some real estate executives are more confident. “My best guess it that we'll see a return to job growth next year, maybe even later this year,” Richey says. “I would not be surprised if it happens a lot sooner or faster than the consensus.”
Two things that the Tampa Bay region and the rest of the Gulf Coast have in their favor now are the lower cost of labor and real estate. “If you look at the last 25 years, we've done very well in slow economies and fast economies when we were competitive,” says Richey, who has been told by economic-development executives that they're seeing increased activity. “Last time I checked, we had no income tax,” he says.
One closely watched indicator of a market's health is the amount of sublease space that's available. Tenants who are shrinking their operations often sublease their space at a discount if they have several years left on their leases.
In the Tampa Bay area, there was about 1.4 million square feet of sublease office space, according to CoStar. Although that's roughly equal to 24 football fields, the amount of sublease space has remained constant over the last four quarters. “We're not seeing the huge amounts being put on the market,” O'Neil says.
That's a sign things aren't getting worse.
In Charlotte, Lee and Collier, the amount of sublease office space is down 15% to just over 100,000 square feet from the beginning of the year to the end of the second quarter. “We are seeing stabilization, and that's good news,” says Mercer.
But sublease space can be hard to track because it's sometimes not reported. Building owners don't like subleases because they undercut existing rents and brokers don't like them because leases are difficult to negotiate.
Feeley suspects there may be more subleases in the market than is reported. “There's over 1 million square feet of sublease space available in Hillsborough County,” says Feeley, who writes a newsletter on the subject. What's more, much of the sublease space comes furnished with office equipment.
Hold on to 2011
For the most part, the common view is that improvement will come in 2011. “I don't think anything will happen in 2010,” says Conn, who works closely with retailers. “Most retailers and anchor tenants, we're talking 2011 and beyond.”
Job creation will be the key. “Before outside businesses come in, we have to have new jobs,” says Mercer. “I don't think we'll see a large uptick in stats for the next 12 months.”
Looking out six months, O'Neil says: “My gut tells me it won't get better, but it won't be worse. We've got a ways to go on the [space] absorption side. We're still losing ground.”
“We really need to get a comfort level on the foreclosure market,” says Johnson-Crowther. “That situation needs to ease up and resolve itself before we see a significant improvement in the retail sector.”
Tenant satisfaction
Tenants on the Gulf Coast now have the upper hand to negotiate better terms on new or renewing leases. Vacancies are rising and many building owners are seeking to refinance their properties, leading them to entice tenants with better deals. Below is a snapshot of vacancy rates from market tracker CoStar Group. The Tampa Bay market includes Sarasota and the Southwest Florida market includes Charlotte, Collier and Lee counties.
Office space VACANCY
Area 2Q08 2Q09
Tampa Bay 10.8% 13%
Southwest Florida 12.5% 15.8%
Industrial space VACANCY
Area 2Q08 2Q09
Tampa Bay 7.2% 9.7%
Southwest Florida 9.2% 13.4%
Retail space VACANCY
Area 2Q08 2Q09
Tampa Bay 5.3% 6.5%
Southwest Florida 5.3% 7.5%
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