Recent statistics indicate that tenants are asking for more from landlords in a variety of different asset classes, and most landlords are left with having to say yes. The leverage in lease negotiations appears to have shifted to the tenants. REITs understanding of the current status of the leasing market is a critical tool to maximizing results in negotiations with tenants. Trends within an asset class and/or a geographical market can provide insight into how to best approach new leases and lease renewals for a property.
Over the past year, markets have generally trended towards a more tenant-favorable outlook across both an asset scope and a geographic scope. Office properties, for example, have seen increases in free rent periods and tenant improvement allowances. According to Savills Studley, in the New York office market, the average value of free-rent periods and tenant improvement allowances, hit $173 a square foot in the first quarter, up 3.3% from a year earlier and more than double from a decade ago. These concessions, in some instances, may be attributable to an increased supply. Not only are new office properties in cities such as New York, San Francisco and Boston increasing the square feet of office space available in those markets, tenants are also using existing square footage more efficiently and consolidating individuals into less square feet. Alternatively, some property owners have been more willing to grant larger tenant concessions in hopes of sustaining or increasing rent levels. This strategy requires a long-term view to maintain the value of a property, focusing on returns from dispositions, financings, or recapitalizations. Additionally, tenant concessions may be more affordable to landlords than in the past due to historically low interest rates.
Office properties are not the only asset class to experience an increase in pro-tenant terms over recent periods. Retail property owners are also facing tenants that are aggressively demanding lower rents and higher tenant improvement allowances. Unsurprisingly, mall tenants are taking advantage of store closures and an increase in retail bankruptcies to leverage more favorable terms. The type of tenant, however, seems to play a role in a landlord’s vulnerability to tenant demands. Restaurants, for example, appear to be able to garner more concessions because of more expensive build-out costs and many landlords’ desires to attract popular restaurants as anchor tenants. Although e-commerce has certainly impacted the market for mall owners, not all mall properties are feeling the effects equally. Malls located in metro areas have generally been able to maintain lease terms and rental rates as the result of continued demand for space.
One particular asset class that may soon play an impactful role in the retail property leasing market is supermarkets. The retail landscape currently contains more food-focused square footage than any other time in history. According to the Wall Street Journal, in 2016, commercial square footage of retail food space reached an all-time high of 4.15 square feet of food retail per person. This increase in space devoted to food sales is the result of both increased store openings and the addition of food options at businesses that have not traditionally sold food, such as pharmacies and gas stations. Moreover, competition within the industry has been on the rise coupled with changing consumer habits regarding food creates questions as to whether closures are in the future for some supermarkets. If these closures do occur, then an increase in supply of retail properties could alter the market in tenants’ favor.
While the terms of a new lease or lease extension must ultimately be crafted to fit the needs of the specific property, property owners that are cognizant of the current pressure points in the market can focus on contractual provisions that will have the most impact on both tenants and the landlord’s bottom line. Landlords can leverage the market knowledge to avoid conceding points that tenants may not be expecting to receive. An awareness of the market can also help ensure that a property owner’s position with respect to a particular term will not hinder finding prospective tenants or alienate existing tenants. Since markets are constantly changing, it is important to stay apprised of new developments so that each negotiation can be undertaken with as much knowledge as possible.