Owners are offering a variety of concessions and perks to maintain rents.
Interesting and unique factors and conditions have come into play in office rents as concessions, and other incentive packages – including furnished space and “free rent”– have firmly made it a tenants’ market right now, industry analysts said.
Colliers released key office rent data this month, including a positive turn for absorption from negative 0.5 million square feet in Q1 2022 to 3.1 million square feet in Q2 2022.
Meanwhile, asking rents showed little change, with average Class A full-service office asking rates falling by 0.4% to $41.05 per square foot in the second quarter.
The Common Remedy to Past Downturns
Cristina T. Sanchez, real estate attorney at Duane Morris tells GlobeSt.com, “While we have not seen asking rents diminish, we have seen landlords and tenants increasingly agree instead to various rent concessions.”
Examples of these rent concessions include “offering free rent periods at the beginning of the lease terms and tenant improvement allowances. These concessions provide the benefit to the tenant of reducing the ‘effective rent,’ while allowing the landlord to obtain its asking rent, and which may also be helpful with any potential financing.”
Petra Durnin, head of market analytics for Raise Commercial Real Estate, sees mostly the same, calling it a trend that has prevailed through the last two downturns.
“Asking rents are stabilizing because landlords are keeping asking rents higher but are offering increased concession packages for tenants,” she said. “Free rent and more tenant improvement dollars, that can also be converted to free rent, help offset a higher starting rent for the tenant.
“Also, the flight to quality is placing a higher demand on Class A space, which keeps asking rents at a premium. As companies implement hybrid workplace strategies, a highly amenitized, custom workplace is necessary to attract and retain quality talent and facilitate in-person collaboration.
“It’s also possible that in some submarkets, activity is concentrated in Class B product, leaving Class A space on the market and stagnating asking rent. Many companies are still seeking the blank canvas of low-rise, free-standing suburban office buildings to carve out their unique brand.”
Owners Must Keep Rents ‘Palatable’
David Oates, CRO at global commercial real estate data platform, Coyote Software, tells GlobeSt.com, that despite being some way off the record peak of 16.3% at the height of the global financial crisis, office vacancy rates have increased this past quarter to around 15%.
“That means it’s a tenants’ market right now, and so it’s hardly surprising that owners are having to keep rents palatable and offer concessions if they want to see their buildings full.
“If you look at cities like Austin – which has bounced back strongly from the pandemic – landlords there have continued to offer high incentive packages, largely in the suburbs, to ensure that tenants sign or renew leases. In that particular market, it has really paid off and other cities are no doubt sitting up and taking note.”
Jeff Shaw, CEO, Bridge Commercial Real Estate, the office operating platform for Bridge Investment Group, tells GlobeSt.com that in office assets across the country, he’s seeing rental rates either flat or increasing.
“Reasons for this are nuanced from market to market,” Shaw said. “In many cases companies are signing leases where markets have minimal supply, allowing landlords to hold or push rates.
“In other markets where there may be more office supply, the increasing construction costs and free rent concessions have bolstered rents with little push back.”
Some Concessions ‘Not Made Public’
Pierre Debbas, managing partner of NYC real estate law firm Romer Debbas, tells GlobeSt.com that landlords will try to maintain the rents that the public can see as high as possible, but the real change in the market is being reflected in the concessions that landlords are providing.
“Such concessions are tenant’s allowances for construction, free rent periods, or construction credits, which are all higher than pre-pandemic levels,” Debbas said. “Those concessions are not made public and thus are not reflected in the asking rents or rental figures that are public.”
Chicago Market Fairly Healthy
Jim Adler, executive vice president, Office Services Group, for NAI Hiffman, based in Chicago suburb Oakbrook Terrace, tells GlobeSt.com that landlords are answering inflationary pressures by increasing concessions 10% to 15% higher than a year ago, such as higher construction allowances and more rental abatement, to attract new tenants.
“In some cases, they are fully furnishing spaces to eliminate tenant concerns over rising costs and/or delayed deliveries,” Adler said. “These new enhanced incentives are supporting sustained rental rates.”
At the same time, the suburban Chicago office market recorded 2 million square feet of new leasing activity during the second quarter of 2022, up almost 19% over the first quarter, Adler said.
“So, while we’re not raising rents yet, the market is getting healthier and we think 2023-2024 will mark a return to normal yearly increases – the recovery is underway,” Adler said.
NYC, Atlanta, LA Top Absorption Markets
Colliers reported that the number of markets with positive absorption rose in the second quarter, with 53% of office markets seeing a gain in occupancy; up from 49% in Q1 2022.
New York City, Atlanta and Los Angeles were the top absorption markets, followed by Denver, San Diego and Phoenix.
It also reported that the gap between asking and effective rates remains significant. Tenant improvement allowances of $100 per square foot or more, accompanied by 12 to 15 months of rent abatement, on a new 10-year lease are increasingly common on Class A space in several leading metros.
CommercialEdge’s Doug Ressler, tells GlobeSt.com, “The average full-service equivalent listing rate was $37.75 per square foot in July, a decrease of 2.3% year-over-year but up 17 cents over June. The national vacancy rate was 15.1% for the month, up 10 basis points over the past year.”