Rents Rise Despite Leasing Malaise As Office Tenant Build-Out Costs Escalate
Companies in the market for office space are failing to find rock-bottom rent deals, even as landlords face a wave of maturing debt and rising market vacancy.
Instead, tenants, who still want shiny new spaces that will lure employees back to the office more often, are turning to landlords who have the capital to fund tenant improvement allowances, even as they are paying near-record-high rents, panelists said during Bisnow’s Atlanta office event last week.
“It’s all about talent. It’s all about trying to recruit the best talent,” Highwoods Properties Senior Vice President Heather Lamb said at the event, held at the Crowne Plaza Atlanta — Midtown hotel. “[Tenants] are not really too concerned about the price point that they’re paying for the real estate. They want to provide an environment that is conducive for their talent.”
In past real estate cycles, landlords dropped rents to induce interest among a dwindling pool of prospective office tenants. That hasn’t happened yet.
Atlanta-area office rents climbed in the third quarter to $30.53 per SF, up from just over $30 per SF during the same period in 2022, according to CBRE. Those rents have climbed even as the rate of office space available in the market hit a new record at 30.7%.
The war for talent has placed the Atlanta office market on odd footing: Because of the higher build-out costs for office space, landlord margins are getting squeezed, which is only adding to their reluctance to lower face rents, Lamb said.
That can lead to difficult conversations with their tenant representatives, like T. Dallas Smith & Co. principal Corey Ferguson, who was onstage with Lamb.
“Companies are then looking at Corey and Corey’s team and saying, ‘OK, I get a better rate, right?’” Lamb said. “No, you don’t get a better rate, because the cost of construction is so high.”
That dynamic is bifurcating the Atlanta office market between landlords who can fund tenants' amenity wishlists and landlords struggling to come up with the capital to offer prospective tenants as they face near-term debt maturities and a lack of lending options.
“Tenants want and need tenant improvement allowances, hence they’re going to well-capitalized landlords,” Lamb said.
JLL Executive Managing Director Adam Viente said brokers are steering tenants to buildings whose landlords have more capital in the bank and can fund TI packages, which is helping push asking rents up.
“I would not be surprised if they don’t continue to grow,” Viente said. “Experiential real estate, which is what most occupiers want, is not inexpensive.”
Construction costs are in part why TI packages continue to go up. While a decline in new development activity has helped to stabilize construction costs, high prices for construction materials and increased pay for labor are helping keep overall costs elevated, according to a recent JLL cost study.
Rubenstein Partners Senior Vice President Mahesh Mani said landlords are willing to stretch on those TI packages to secure tenants, especially for longer terms. The competition is fierce because there are fewer tenants in the market for space. Leasing activity was 34% below its pre-pandemic average in the third quarter, according to CBRE.
“You've got to bite the bullet and do it or be taken off the grid,” Mani said.
Panelists said that features like fully furnished spec suites and spaces with an abundance of private offices are getting more attention among tenants. Open office plans conducive to hot desking have fallen out of favor.
“Most tenants we’re seeing want some offices,” Lincoln Property Company Southeast Executive Vice President Hunter Henritze said. “We've got a number of wide-open spec suites that we’re struggling to lease.”
