The economy has made positive news of late as storm clouds start to clear giving way to glimmers of recovery. Leading indicators of employment growth, such as hours worked and hiring at temporary staffing firms, have been on the rise.


Positive employment news, however, will take considerable time to translate into future demand in the commercial real estate market. Shadow vacancy, leased office space that is neither occupied nor marketed for sublease space, has become an increasing obstacle to recovery.


Commercial real estate market fundamentals historically lag the overall economy by six to nine months. But with firms overloaded with excess capacity, a recovery may be pushed further into the future. This recession has affected demand much differently than previous downturns. 


During the recession earlier in the decade, isolated industries, such as technology companies, quickly seized large blocks of space in anticipation of future growth. Since growth never materialized, much of this space was never actually occupied. When layoffs began, the pain was acute, and the disposition of large blocks of space was easier to market through sublease.



Casting Large Shadows


This recession has had a broader impact on all sectors and industries. Most companies have had some form of layoffs over the past two years. In some cases these layoffs were small enough that it would be difficult for firms to market occupied space on the sublease market. 


Take, for example, a firm with 50 employees in downtown Boston that laid off 10 percent of its workforce. Although a significant loss for the firm, the square feet vacated by these employees would likely be too small to market. In individual examples, this “shadow space” is small, but collectively these small pockets add up to a sizeable portion of the market.


Shadow vacant space has caused the traditional vacancy rate to underestimate true vacancy. With bluer skies on the horizon, many companies have decided to hold on to empty space. As companies rehire, this space will be the first filled as firms grow organically within their space. Therefore, shadow space will create a prolonged period of weak tenant demand and will lengthen the recovery of market fundamentals.



The Meaning For Tenants


Weakened market fundamentals and an uncertain economic environment have created a tenant-favorable environment. Until recently, however, tenants were so focused on stabilizing core business operations that they were unwilling to enter into negotiations to renew a long term lease or relocate. 


This air of uncertainty has created opportunity as owners remain focused on maintaining occupancy and stabilizing cash flow. Tenants burdened with excess unoccupied space may be able to negotiate with their current landlords. Depending on numerous factors, including major lease roll in the building or pending debt maturity. Landlords may be willing to exchange lower rents or space reductions in return for a lengthened lease term. 


Tenants with pending lease expirations should enter into negotiations early. This tactic, called “blend and extend,” may be a viable alternative for both parties. If a landlord has a mortgage expiring, they will want to shore up occupancy before entering into refinancing negotiations. 


Credit-worthy tenants are also a valuable component of an asset’s value. Firms should leverage this factor. Tenants could also benefit from possible reductions in tenant improvements, rent concessions and reestablishing their tax and operating bases. 


The key to any lease negotiation is knowledge and leverage. Tenants looking for a home-run deal must do their homework on the prospective landlord. Understand weaknesses and negotiate from strength to capitalize on the opportunities in today’s market.

Bill Motley is managing director of Jones Lang LaSalle in Boston.