Plenty of Room to Bargain in San Diego : High-Rise Offices Going Begging
These are not high times for owners of downtown high-rise office buildings.
With vacancy rates for downtown high-rises hovering at 25%, more than 1.3 million square feet of downtown San Diego office space is gathering dust instead of generating income.
That glut, fueled largely by high-rise construction in the last five years, has landlords making concessions to fill their empty floors.
“Everyone is price-conscious,” acknowledged John Donovan, a sales consultant with John Burnham & Co. who is handling leasing for the First National Bank Building, which is 57% leased. “Regardless of how nice your building is or how great the location is, you might have to make concessions.”
Or, as another leasing agent bluntly stated, “Office space is just office space when you’re standing behind the desk,” no matter the touted amenities, services or “unique attractions” of San Diego’s office buildings.
Consequently, “anyone with a creative mind can come up with tens of hundreds of different ways to structure a rental provision,” said Ira Waldman, a partner with the Los Angeles law firm of Cox, Castle & Nicholson, which helps tenants bargain for better office leases in San Diego and other parts of Southern California. “You can pick your own poison.”
San Diego’s office landlords are most likely to offer free rent or fatter tenant improvement allowances--that is, what the building will spend to partition off office space, install carpeting, cover walls and provide lighting.
Free rent, however, is generally reserved for long-term tenants--at least three years in some buildings, with a five-year minimum at others--who lease space by the floor and who are likely to re-sign on the dotted line when the lease expires.
Free office rent in San Diego means “one month for every year of the lease,” suggested John Norton, an account executive with Merrill Lynch’s realty investment group. Free rent, he added, will not cover the tenant’s share of a building’s operating expenses.
In addition, Donovan cautioned, free rent, like the proverbial free lunch, usually has strings attached.
Tenants leaving lower-priced quarters for another building often “go fat, dumb and happy for a year, but then all of a sudden the hammer falls” and a new, more expensive lease kicks in, Donovan said.
Although a tenant firm may believe it has penned a good deal, “you simply can’t charge a $1 (per square foot) for a building that costs $2 to build,” said Bill John of Grubb & Ellis’ office property division. “The building may give out concessions up front, but when the concessions go away, the pro forma rent is going to kick in.”
Although landlords are giving away free rent, they generally will not consider reducing rental rates because lease rates must be attractive to their lenders and future buyers.
Financial institutions and would-be purchasers “look at the income being received (and would) rather take it in the shorts up front and show higher income later,” explained Paul LeFrenz, a sales consultant with Coldwell Banker.
As a result, the building owner who stands fast against reducing rental rates will readily sacrifice a year’s rent to help persuade a highly desirable tenant to sign a five- or 10-year lease, LaFrenz said.
The offers of free rent also attract companies “that have a propensity to stay, who won’t be leaving after the lease expires,” said Gary H. London, vice president of the Goodkin Group, a San Diego-based firm that analyzes office and commercial space availability.
There are also more ephemeral factors behind the free rent offers.
“The longer the building is empty, the worse it looks,” said Waldman. “Landlords are more willing to make a deal with someone who . . . is going to be the drawing card.”
Firms that don’t qualify for free rent--or for whom free rent simply isn’t enough--are pushing landlords to provide above-standard tenant improvements packages.
“The theory is that fixtures, furniture and other improvements enhance the value of the entire building, and this applies everywhere from the lobby to the corridor in the space the tenant rents,” Waldman said.
While a typical tenant improvement package might allow for $15 to $18.50 per square feet, said Norton, a desirable tenant might successfully negotiate $3 to $5 per square foot above that.
What’s up for negotiation? “Go for (better) carpeting and wall coverings, talk about extra soundproofing or a telephone system and better light fixtures,” Waldman suggested.
Tenant improvements also play a role for tenants who don’t want to move, said Waldman, whose firm is renegotiating the lease on its Los Angeles office. “We’ve been here 10 years and we want to make (our office) look better,” he said. “Color schemes do change, and we want soft grays and blues, not the shocking reds and oranges that dominated 10 years ago.”
Tenants will keep the upper hand for the next two to four years, Carlson predicted: “The office market is not absorbing space like some would have you believe.”
Leasing agents say the bottom line in negotiating is governed by where a tenant needs to cut costs.
Tenants should decide if they “want to reduce operating expenses or cut capital improvement costs,” suggested one leasing agent. “Play the game of what’s available. Be an informed negotiator because (the owners) are definitely not going to tell you what’s negotiable.”