As the COVID freeze lifts, companies of just about every size will have a roughly two-year window to strike a favorable office space deal. Tenant rep Craig Braham explains in the latest edition of Crain's Private Intelligence.
As the coronavirus pandemic took hold last year and companies ordered their employees to work from home when possible, expectations rose that employers facing a recession would soon be seeking to cut loose big chunks of their office space.
Since then, many employers have been delighted to find that worker productivity has actually been improved as people have grown used to working from home with fewer in-office distractions. That’s got some landlords fearful that tenants in the throes of reorganization might be cutting back on space commitments significantly this year as leases come up for negotiation.
But the scenario is more complicated than that, Craig Braham believes. The CEO of Advocate Commercial Real Estate Advisors, based in the West Loop with a branch office in Detroit, Braham has increased the size of his staff to 20, all back working in the office, and preparing to move to new quarters with a 70 percent increase in space. In the process, he’s about to enjoy a big decrease in his monthly lease payments.
Braham, 55, founded Advocate Commercial in 2003 as a tenant-only rep firm after working for such Loop brokerages as Newmark Knight Frank, Staubach and Goldie Wolfe. He recently acquired a smaller Chicago rival, ProTen Realty Group. Excerpts from an interview follow.
Crain’s: What was the impact of COVID-19 on your business last year?
Braham: Last year our transaction volume was down 80 percent in Chicago as everybody was hunkering down. A lot of tenants decided to put decisions on hold. If they had a lease expiration coming up and had to do something, we tried to negotiate for them a short-term extension of a year, which amounted to kicking the can down the road. Landlords, under the circumstances, were amenable to that.
For the past decade Chicago has been a landlords’ market, with building owners dictating prices and terms. With the onset of the coronavirus we’ve seen a very quick transition from a landlords’ market to a tenants’ market. Credit the law of supply and demand for this: Right now we have more than 5 million square feet of discounted sublease office space being offered in downtown Chicago, which is four to five times the norm. All this sublease space is driving down rental rates.
Companies that had been growing and inventorying space are now deciding they don’t need so much. As a result, it’s a very good time to be a tenant.
It’s a good time if you are actively seeking space, you mean.
In a typical year, 75 percent of our work is driven by lease expirations and 25 percent by lease restructuring. In the next two years I expect that ratio to flip as many tenants who aren’t even facing the end of their leases look to renegotiate. If you are in a space with more than three years left on your lease you are almost certainly paying above current market rates. You have a real opportunity to go to the landlord now and get concessions.
Please give an example of how that can work.
Say you are a firm with 30,000 square feet in Chicago but find now that you will only need 20,000 feet going forward. You could try to put the extra 10,000 square feet on the sublease market, but if you do you’ll find you’ll be forced to discount it by as much as 75 percent and be losing big money. But if your lease is due to come up in two years you could go back to your landlord now and persuade him to take the extra space off your hands.
In return, you tear up the old lease with two years left to run and sign a new lease to run 10 years. Your new deal will carry a monthly lease rate priced lower than what you’ve been paying. Many landlords face sizable debt negotiations on their properties in the next couple of years and they don’t want to lose tenants. They are highly motivated to make deals.
Your own space is at 311 S. Wacker, across from the Willis Tower. What deal are you doing?
We have 5,000 square feet in a Class A high-rise and our lease was up last year. We kicked the can for a year, and with another lease expiration coming up in July we decided to move. We are leaving this building, where we are paying $48 a square foot gross, and moving a block away to an 8,000 square foot sublease where we will be paying $20 a foot gross, with some free rent included.
It’s a great deal, with our lease expenses cut dramatically. But the sublease will be up in two years, and so a year from now we’ll have to start looking again for space. One option might be to go to the landlord of the building and try to negotiate a longer term. A landlord won’t go as low as $20 on a direct negotiation, of course, but might go to $38 to $40 a foot gross, with some free rent included.
Free rent and tenant improvement allowances are something that landlords use to prop up their official lease rates, right?
If you are paying $40 a foot gross now and doing a new deal you might get the price down to $36. But I’m seeing landlords willing to throw in 18 months of free rent on a 10-year lease. Two years ago they might offer tenant improvements priced from $120 to $140 a square foot in their concession packages. Now they’re offering as much as $160 a foot.
Concessions haven’t been this good at any time since the commercial real estate crash of the late 1980s and early ‘90s.
I did a deal for a law firm back then where we negotiated four years free rent on a 12-year lease. We’re not at that point yet.
It’s a fact, however, that big public company tenants are able to negotiate better terms than private companies with no public stock in back of them?
Yes, public companies generally carry better credit and get better deals. A big name like Google isn’t going to be asked to put down a security deposit, but a smaller tenant will be asked for a deposit to mitigate the landlord’s risk. The landlord will want to see your financials for the last three years as well as your balance sheet. If a law firm is taking 8,000 square feet and they don’t have many assets to show, the landlord recognizes that if those lawyers suddenly disband and leave bills unpaid he doesn’t have much to chase after except perhaps accounts receivable. So they will have to pay a security deposit.
Is this the right time to negotiate for the best deal? Is it possible that terms for tenants will get even better in a year or two?
It’s tough to pick the bottom of the market. It’s possible some prices will go even lower a year from now, but they aren’t likely to go change dramatically from here. At the moment, it appears that tenants will have a nice two-year window of opportunity to get good deals.