Where Downward Pressure On Rents Comes From

From NREI:

The era of rapidly rising office rents that dominated the booming property markets in 2006 and 2007 has reversed course, giving tenants the upper hand at the bargaining table. In fact, New York-based research firm Reis expects a 7.4% drop in effective office rents this year after growing only 0.3% in 2008.

U.S. companies shed more than 4.4 million jobs between December 2007 and the end of February, according to Bureau of Labor Statistics. That has helped push the office vacancy rate to 14.5% in 2008 from 12.6% in 2007, according to Reis, which tracks 79 office markets in the U.S.

In 2006 and 2007, office rents grew 9% and 10.6%, respectively. Aware of the crumbling fundamentals, tenants are renegotiating virtually every lease deal that has been in the pipeline since last summer, brokerage executives say.

New York-based tenant rep Studley, for example, started working with a client midway through last year and initially anticipated a lease rate of $50 per sq. ft. The client recently signed for $28 per sq. ft., says Michael Colacino, president of the brokerage, who declined to name the tenant.

“It’s a harsh landscape, and if it wasn’t for the larger, gloomier context of the entire U.S. economy being troubled, I think people would take it a lot more personally,” he says. “But falling markets equal price discovery, and re-negotiation is the red-headed stepchild of price discovery.”

James Garibaldi, president of Chatham, N.J.-based service provider Garibaldi Group, says that office tenants are acting increasingly like retailers, who for several months have pressured landlords to renegotiate leases or downsize their space.

Garibaldi and other brokerage executives add that office tenants increasingly are delaying lease decisions. Uncertainty about the timeline for economic recovery is one reason, but tenants are also betting on further rent deterioration.

Ultimately, however, the lion’s share of tenants are choosing to renew rather than move, says Garibaldi, who is beefing up his tenant rep business.

“The decision process has become as excruciatingly long as any time in memory,” he adds. “Landlords have become increasingly aggressive, making for a far more competitive arena.”