Office tenants gain advantage amid changed market dynamics

Negotiating for square foot price is now possible

Office tenants gain advantage amid changed market dynamics

The commercial real estate market is changing with the economy, and tenants are taking the driver’s seat as it relates to negotiating leases for office space.

Michael Thom, an attorney in the business and finance department at Obermayer, focuses his practice on public and private financing and real estate transactions. He took time to speak about the changing CRE landscape with Mortgage Professional America amid a changed landscape. 

“Landlords are having trouble leasing certain kinds of space, and that’s a combination of the workforce downsizing and people laying off employees as the tech industry recently announced,” Thom said. “Or it’s a combination of people coming back to work after COVID where people are now working from home - some companies are allowing people to work from home and their demand for space isn’t as great.”

Sadly, for landlords, banks don’t make such distinctions: “If you’re a landlord who’s carrying the mortgage, your bank doesn’t necessarily care if it’s leased or not,” Thom said. “They’re making a loan to you to pay and, yeah, when they underwrite the loan, they base it on the tenants but at the end of the day when the tenant goes away, they don’t say ‘sorry your took a loan out on us, but we’re going to give you a pass’.”

Read more: Office market categorized as ‘the big slowdown’

Such a scenario can be rough for landlords, Thom suggested: “As a result, tenants in some situations they really have the landlords by the throat, because landlords need to have some people in there to oversee their debt service because they have to come out of pocket for it.”

It comes down to finances: “Some of your bigger operating companies can do that but a landlord who bought a great commercial building in the middle of COVID because interest rates were 2.5% who never did that before – they generally don’t have the clarity to start writing checks every month.”

The changed landscape yields leverage for tenants, Thom said: “You see tenants coming in saying we want the space, but here’s our terms. They’re able to structure in their favor when they find the right landlord. Those landlords just need to get someone in there yesterday.”

There’s the rub: “Instead of maybe doing $15 per square foot, they can get in there for $9 or $8 or $10 because they found a landlord who has a loan coming up and they need to refinance or they need to carry their debt service or some other reason why they can’t afford to have that space empty.”

This is what gives tenants negotiating power, Thom explained, so long as the economy remains depressed: “With more office space than people need, tenants have secured negotiating power and the ability to structure leases in their favor,” Thom said. The opportunity is brought on by a mix of market conditions that is to adversely affect landlords, he summarized.

Read next: Higher rates putting brakes on commercial real estate

The present scenario is enough to give landlords pause, Thom suggested: “I think they have to take a deep look inside and say ‘what do I want’. If they can afford to hold out and to get terms they’re used to getting, they should, by all means, do that. But a lot of them can’t, and even your multi-million dollar properties in Manhattan and these Class A buildings, those landlords are having trouble keeping people in. When you see those big fish having to make changes and how they’re shifting their thoughts on tenants, it really starts a downward spiral to a certain point.”

Yet even with the changed dynamics, landlords retain some measure of control: “I think you’re going to see more tenants favor negotiations in the traditional office space,” Thom said. “I think your industrial and multifamily spaces and warehouse and the industrial group, landlords have a lot of control because the reality is they still need a place to live – the demand is there. But in office space, I think you’ll see landlords who are going to make changes – either more amenities, or more beneficial lease terms, or an option to reduce space, or early termination options, something like that – to really pull tenants who are hesitant or who don’t want to renew.”

So, for now at least, advantage tenants.