Tenants have upper hand in lease deals

With the lease winding down on his law firm's Universal City offices last year, Ray Hamrick figured that he was going to have to move because his rent would be rising beyond what he could reasonably pay.

Reluctantly, he started looking for space in buildings that weren't as desirable as the sleek, 35-story high-rise on Universal Hollywood Drive that his firm had called home since the 1980s. Then the global recession took hold, and his building, the tallest in the San Fernando Valley, went into foreclosure. The lenders who got it back immediately wanted to deal.

Rents in the building had been as high as $4.50 per square foot a month, but after a few rounds of negotiations earlier this year, Hamrick & Evans got a five-year lease at $3 a foot plus 12 months of free rent and other concessions that brought the net price down to about $2.40 a month, said Hamrick's broker, Jake Bobek of real estate brokerage Cushman & Wakefield.

"They were pushing really hard to keep me there," Hamrick said. "It made me able to stay here where I wanted to be. I feel fortunate."

Hamrick's deal may have been better than most, but it reflects the state of the commercial real estate rental market, which markedly favors tenants. Unfortunately for landlords, their willingness to deal often comes to naught. Many tenants are too overwhelmed or too uncertain to make a commitment to expand, and competing landlords are going all out to keep business.

"It's certainly a tall order to get a tenant to move today," landlord David Binswanger said wistfully.

Binswanger knows what he's talking about. After agreeing last year to move into new buildings Binswanger's company built at the Playa Vista development near Marina del Rey, Fox Interactive Media got cold feet at the last minute.

The Fox division, which includes the social networking website MySpace, faced layoffs in June and no longer wanted the nearly half-million square feet of offices it had promised to rent from Binswanger's firm, Lincoln Property Co., for about $350 million over 12 years.

Fox still has to make rent payments, but it is trying to sublet its unoccupied offices and get some of its money back. Lincoln, meanwhile, kept building more office space at Playa Vista because it thought it had filled up the first phase of its development with Fox's lease. Put simply, Fox is now competing for tenants against its own landlord and other office building owners on the Westside.

Fox's emergency swerve away from Playa Vista was another blow to the commercial real estate rental business, which has been in decline for almost two years. The slump affects more than landlords; when space doesn't rent, development of new buildings soon stops and that drains energy from the local economy as well-paying construction jobs disappear.

"Los Angeles has always been a real estate development game, either residential or commercial," said Jack Kyser, founding economist of the Kyser Center for Economic Research at the Los Angeles County Economic Development Corp.

"It looks like residential may be starting to breathe again," Kyser said, "but when you put a the mirror under the nose of commercial, there is no sign of life."

With overall office vacancy in Southern California rising to more than 17% at the end of the third quarter from 13% a year earlier, the power has clearly shifted to tenants when it comes to negotiating leases. Some markets are tighter than others -- buildings in Pasadena are just over 10% vacant on average -- but for the most part it's a tenant's world.

Although a few landlords have buildings so desirable because of their stature and location that they can still command top-tier rents, most owners have been forced to lower their prices to get leasing business. Overall asking rents in Southern California have dropped 7% in the last year, according to Cushman & Wakefield, but that's only a slice of the incentives landlords are bringing to the negotiating table with tenants.

Loath to set lower rent benchmarks because they reduce a building's value, landlords look for other ways to cut tenants' costs and perhaps stroke their egos.

Want us to wrap the building in a giant nylon "supergraphic" announcing your arrival for a few months? We'll make it happen, some landlords say. Want us to promise we'll never put an advertising supergraphic on the building because you think they're tacky? Glad to, other landlords respond.

Most landlords and tenants agree not to talk about the terms of their leases to preserve their financial secrets, but tenant broker Jonathan Larsen of Transwestern confirmed that he recently negotiated a promotional supergraphic for a new tenant in the South Bay.

Larsen has also been exploring new fronts for what might be called "naming rights," similar to university facilities named after donors or parts of entertainment venues named after paying sponsors, such as Club Nokia at LA Live.

Putting the largest tenant's name at the top of a building has long been an established practice for landlords who want to fill large blocks of space. The former Library Tower in downtown Los Angeles, the tallest building in the West at 72 stories, has been renamed twice, first as First Interstate World Center and now as US Bank Tower.

Larsen is taking a further step for smaller tenants that don't rate building-top signage by asking for other parts of the property to be named after the tenants. An outdoor garden area might get a sign proclaiming it the Acme Insurance Courtyard, for instance. Larsen is negotiating such a deal now, he said, but can't reveal the names of the parties yet.

On occasion, tenants successfully demand what is referred to as "Proposition 13 protection," said industrial broker Walt Chenoweth of CB Richard Ellis.

Some leases require tenants to pay a portion of a building's property taxes. Under California's Proposition 13 rules, buildings are reassessed at their new values when they are sold, potentially raising property taxes substantially. If tenants negotiate protection, they are shielded from paying more taxes and may even get a tax reduction if the landlord gets the building reassessed at a lower value.

Other extra sweeteners might include free memberships in an on-site gym or dining club, but those perks usually don't make financial sense for landlords unless they own the facilities and don't have to pay a third party for the privileges.

Besides, people usually don't place much value on free stuff, said Peter Johnston, who is in charge of leasing for one of the region's largest landlords, Maguire Properties Inc.

"If you give them a free gym membership, they won't use it," Johnston said. "If you charge $5, they might."

The primary landlord concessions that put new tenants in empty space or inspire existing tenants to stick around when their leases expire are old standbys: periods of free rent and subsidized improvements to the rented space such as carpeting and paint.

With many landlords suffering cash problems in the down economy and with lenders reluctant to give them loans, available funds for tenant improvements often are restricted. That leaves rent concessions as the biggest carrot they have to offer.

"Gimmicks are nice, but at the end of the day it's rent and parking" concessions that seal a deal, Johnston said.

Free rent can take many forms. Tenants might be allowed to move in before the official lease begins, even if improvements such as building individual offices and painting are still taking place.

More commonly, landlords agree to offer a certain number of months of occupancy free in exchange for a tenant's commitment to stay in the building for several years. For example, a tenant might get four to six months free for signing a five-year lease.

Parking is another category in which cash-strapped landlords have room to deal. Although free parking is common in Orange County and the Inland Empire, parking can be a substantial expense for companies and their employees in Los Angeles County.

In Maguire's downtown buildings, parking fees start at $240 a month and run as high as $580 a month for a reserved spot at US Bank Tower.

Landlords like to keep confidential the level of discounting they agree to, but brokers and landlords agree that the perk usually is reserved for tenants with the best credit who are least likely to default on their leases.

Discounts and breaks won't last forever, of course, but the rental market is still expected to get softer before it gets better for landlords. At least vacancy is now rising at a slower rate, according to a third-quarter analysis by CBRE Econometric Advisors.

"Like with job losses, the worst period of vacancy increases is behind us," said Jon Southard, CBRE director of forecasting. "Still, this is of little comfort when 'less bad' only adds to record high vacancy rates in many markets and property types."



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