Conditions Ripe For Tenants To Renegotiate Leases

The coronavirus pandemic has unsettled the economy like no other event in modern history, prompting some office tenants to hunker down and put off big decisions. But by emptying out offices, the crisis also upended what had been a landlords' market, and tenants with leases set to expire over the next few years now have a big advantage.

Savills Vice Chairman Lisa Davidson said her firm is sending a message to tenants who say they are adopting a wait-and-see attitude, hoping that the market loosens up even further over the next year.

“We’re saying the resounding answer to that strategy is, ‘No,’ she said. "Even though we all have a feeling that the market will be softer a year from now, it’s still best practices to see what’s available.”

There may soon be more space available than at any time in the past two decades. After the dot-com crash in 2000/2001, more than 6M SF of sublease space hit Chicago’s downtown office market, Davidson said.

The current amount of open space now stands at about 4.5M SF, but with so many people working from home, office users may be ready to shed even more, and Savills forecasts it could hit up to 6.7M SF next year. Similar conditions prevail across the U.S., she added.

Davidson said that she advises her clients with lease expirations, even if the dates are several years away, to do what they would normally do regardless of the pandemic: brainstorm how their space needs might change, what configurations they will need in the future and whether their present locations still make sense.

That’s more difficult to do now, she added, with so much uncertainty over what the office of the future will look like. Some businesses are just trying to figure out how to survive economic calamity, and others are thinning out in-office personnel. But companies need to balance those difficulties with what they can achieve if they at least initiate discussions with their landlords.

“Right now, it’s definitely a time to potentially lock in favorable rates,” she said. “Not every landlord is willing to face the reality of the moment and offer bargain-basement pricing, but we are encouraging tenants to go through the process and see what can be had.”

She has already seen what some tenants negotiating in the present atmosphere can win. Short-term leases, those with roughly three years or less, can be signed for especially steep discounts of up to 40% in at least a few downtown Chicago buildings.

Rent levels in the city’s Central Business District were already declining before the pandemic, partly due to the construction of many new office towers, especially in the West Loop and Fulton Market. After average effective rent reached $36.34 in Q1 of 2019, it sank to $34.05 by the end of the year, according to Compstak data in a Savills’ market report. It sank even further when the pandemic hit, hitting $31 in Q3.

Landlords are so far unwilling to lock in huge discounts over the long term, Davidson said. Even so, tenants currently looking for new long-term leases have been able to find discounts of between 10% and 15%, as well as other bonuses.

“Concessions are becoming substantial, particularly when it comes to rent abatement,” she said.

Chicago-based Vestian focuses on corporate occupiers in domestic and foreign markets, and Chairman Michael Silver said clients should shoot for two months of free rent for each year of a new lease, as well as generous allowances for tenant improvements and significantly lower rents. If tenants are willing to be that aggressive, it could significantly fatten their bottom lines.

“Taken together, it could mean a 20% to 30% discount from typical pre-COVID arrangements,” he said.

Still, despite the switch to a tenants’ market, securing a dream lease may not be easy. The popularity of work-from-home models, their long-term impact on tenant demand and uncertainty over how long the crisis will last have all left landlords confused about the future, and occupiers will need to put in a lot of work if they want a deal.

“The landlords right now don’t know where the market is, so instead of just saying, ‘make me an offer,’ tenants have to be very specific about what they want,” he said.

Landlords also need a detailed understanding of how companies’ space needs will change in the new environment, Silver added.

“Remote work is not going away, it’s going to permanently change the demand for office space,” he said, estimating that many users will only need 60% to 70% of their pre-pandemic space. “Conditions are going to improve, but it’s not going to go back to where it was before the virus.” 

Both Davidson and Silver said there will be a transitional phase where many owners try to cling to the lease rates and concession levels they won in the recent past. “I can’t blame them, but it’s not going to work,” Silver said.

Either way, a favorable tenants’ market will last for years and will force a change.

“There will be more and more landlords ready to meet reality,” Davidson said.