Office Tenants Bet on Early Renewals
With Southern California’s office market lingering in the doldrums, many tenants are taking advantage of the situation by renewing their leases while they have an edge over landlords.
The strategy is a gamble on the part of tenants, who are betting that rents today are lower than they will be a year from now.
Landlords may not like negotiating under such conditions, but the growing number of early renewals is a noticeable improvement over the lack of leasing that has characterized the market in recent months, say industry observers.
“More companies have a sense of security about what’s going on in their business, and they are willing to commit early to take advantage of the economic conditions in the leasing market,” said Steve Case, senior managing director for CB Richard Ellis in Orange County. “It’s an encouraging sign.”
Depending on their size, most tenants start talking to their landlords about renewing leases six months to 24 months before their current agreements expire.
Some tenants now are beginning discussions as much as three years in advance. “Of the business being done, it’s probably the majority of the deals,” said Julien J. Studley Inc. broker Howard Sadowsky of early lease renewals.
Although tenants can avoid future increases and, in some cases, reduce their current rent, the strategy could backfire if the economy and real estate markets continue to weaken.
“Rates could drop again and tenants are going to say, ‘Maybe we should have waited,’” said broker David Thurman of Grubb & Ellis.
However, if tenants wait too long, their bargaining power may wane.
“The best time to be a tenant in the marketplace is when the perception is that the markets are still declining,” said Dave Toomey of Cresa Partners, a real estate brokerage. “Once things start to pick up, and landlords start to see activity and the vacancy rate drops below 10%, then tenants start to lose their leverage.”
One of Toomey’s clients, accounting firm RBZ, had three years remaining on its full-floor lease in Brentwood when it approached the landlord about renewing.
The landlord agreed to start discussions, and the firm stands to save an estimated $1 million over the life of the new 10-year lease by avoiding an anticipated turnaround next year in the Westside market.
“We think the market is going to be a landlord’s market, and we might have gotten hit with a higher rental rate at that time,” Toomey said. “Right now is a very good time for a tenant to be in the market. We think it will continue to be the case for the next 12 months. Maybe longer.”
Landlords who agree to sign a deal now may lose out on a possible increase in lease rates. But they can take comfort in retaining tenants who now have the flexibility to shop around in a market with ample amounts of vacant space, brokers say.
Freight hauler Conway Western Express started negotiating its lease renewal last summer, even though its agreement does not expire until early 2003.
Conway was able to take advantage of lower rates and committed to a 10-year lease and will expand into 26,000 square feet of space, said broker Travis Boyd at CB Richard Ellis.
