The prolonged standoff between tenants and landlords in the downtown Boston office market may be coming to an end. Leasing activity still remains largely constrained, and landlords have yet to escape heavy downward pressure on rents. However, after playing a waiting game for most of 2008, tenants and landlords are slowly coming together again as the leasing market resets.
Landlords are becoming increasingly flexible as they seek to maintain occupancy and cash flow in today’s difficult economic environment. During lease negotiations, financial tools such as free rent, rent relief, and concessions are being used aggressively to entice tenants to either relocate or renew.
A controlled approach to rent reductions is driving the need for these concessions. At the peak of the market in 2007, rents appreciated 45 percent. At the end of Q1 2009, asking rents were down 20 percent compared to 12 months prior. While rents will continue to soften over the next several months, tenants looking for a 40-50 percent price cut will likely be out of luck.
One thing is clear. Both sides have reassessed their financial standing and are willing to enter into real negotiations. While rent abatement and concessions are becoming increasingly available, major rent reductions are not and it’s leaving a gap between landlords and tenants.
Despite a constant stream of gloomy economic news, Boston landlords remain positive on market fundamentals. The lack of new construction combined with major infrastructure and transportation improvements, a diversified economy, and a well-educated workforce guarantee that over the long term the market will remain tight.
Level-Headed
Tenants, many of whom have experienced downsizing, have a better understanding of future real estate needs. Tenants have adopted a “flight to responsibility” attitude and plans for expensive build-outs in premier towers are being shelved. Instead, tenants are actively seeking to limit capital expenses and reduce occupancy costs. In order to meet this demand, landlords are offering “turn-key” space, or space that is ready for immediate occupancy.
Typically, tenants will receive a tenant improvement allowance to help offset the cost of building out new space. When tenants manage and direct the complete construction process, the build-out phase is capital intensive and susceptible to cost overruns.
Conversely, a turnkey build-out minimizes the cost risk associated with construction, and shifts financial responsibility to the landlord. Traditionally this option was limited to smaller sized tenants. However landlords are now beginning to offer turnkey space options to large marquee tenants as competition heats up in the office market.
Tenants and landlords are beginning to comprehend the current economic situation, and recognize that compromise and flexibility are key in a successful lease negotiation. Tenants have retrenched and are entering the leasing process with a clearer understanding of their space needs. Landlords have taken stock of the increasing number of sublease space options available, and are adjusting their financial expectations to be competitive.
Looking forward, the use of creative financial engineering to complete lease transactions will likely increase in popularity as tenants and landlords strive to transact. The pressure of lease expirations will force reluctant tenants to act, and leasing activity will slowly gain traction during the second half of 2009.
Tenants should focus their attention on the overall effective rent offered by landlords, which can include attractive concessions. Once leasing activity starts to accelerate, the market will tighten quickly and some tenants may miss out on great opportunities.
