Pandemic Puts Developers Under The Gun To Lease New Office Towers
The coronavirus pandemic has complicated leasing efforts for office buildings that are trying to open for tenants this year.
Those projects have lenders who expect their borrowers to fill up their towers within a certain amount of time, achieving a value greater than the cost to develop them. The pandemic's effects on the economy, though, has put developers under the gun to get space leased and projects stabilized even as companies pause on making major capital decisions.
That has some developers changing the way they market space, pumping up incentives to compete for the few tenants that aren't frozen by pandemic fears.
“Right now, most things are on hold. There are some tenants that are proceeding ahead,” The Allen Morris Co. CEO Allen Morris said. “A lot of tenants have gotten short-term extensions on their existing lease where they are.”
Florida-based Allen Morris is underway with the Star Metals mixed-use project in West Midtown off 11th Street. The office component, 217K SF above 60K SF of retail, is set to deliver this year with only a 56K SF Spaces coworking location pre-leased. The developer also inked a deal for a 10K SF restaurant and dart-throwing venue from Social Entertainment Ventures.
When Allen Morris underwrote the project to get construction started, it projected that Star Metals would reach stabilization, generally between 80% and 90% leased, by the second quarter of 2022.
“We're moderating our expectations because we just don't know,” Morris said. “Most office leasing is dead right now.”
Office leasing activity in Atlanta during the second quarter was down 50% from the same period a year ago. Across the country, deal flow may have shrunk even more, by as much as 75%, Portman Holdings Director of Leasing Travis Garland said.
Typically, developers expect to stabilize office buildings within 24 months of delivery, but without activity before that deadline, lenders get nervous.
"Two years is a long time," Garland said. "What if you sit for 12 months and do no leasing? None of these models contemplated sitting in an empty building.”
Trammell Crow recently delivered Twelve24, a 16-story, 335K SF office tower connected to the Dunwoody MARTA Station in Central Perimeter, with 72% committed, mostly for the headquarters of Insight Global. When Trammell Crow underwrote the project with its equity partner and lender, CBRE Global Investors, the two firms projected it would be fully leased by February 2022, Trammell Crow principal Brandon Houston said.
“We had [letter-of-intent] negotiations with two different tenants, and they hit the pause button,” Houston said. “We have several office buildings around the country that are in the same predicament.”
On the whole, office developers in Atlanta are in a better position to weather the downturn than they were in 2008. As of the second quarter, 6.2M SF of office was under construction, according to Newmark Knight Frank. Sixty-two percent of that is already leased, according to Transwestern, and some big deals are still getting done, like Microsoft's major deal for Hines' Atlantic Yards in Midtown and Rooms2Go's relocation to Brookhaven.
Fewer deals mean more competition among landlords. Given the uncertainty of how long a vaccine for the coronavirus will take to be developed, office landlords may feel compelled to push up incentives, T. Dallas Smith & Co. principal Cedric Matheny said.
“I seriously doubt that the terms that they had in March are going to be the same deal terms today,” Matheny said. “You're not doing a lot of deals right now. So if you're hungry for a deal, you've got to put your best offer on the table.”
Typically those incentives will focus on periods of free rent and increased tenant improvement packages. During recessions, those packages can grow as landlords stretch to attract tenants.
If leasing continues to slog through the dampened economy, landlords may eventually be willing to chop the actual rental rate, especially for the right tenant. But that typically is landlords' last resort.
“Right now, everyone's talking about free rent and T.I. They don't want to touch the rate,” Newmark Knight Frank Executive Vice President Sean Moynihan said. “When you do that, you're impacting the long-term value.”
For Trammell Crow and Allen Morris' projects, the major change has been in marketing, emphasizing amenities and features of the projects that have a post-pandemic appeal, like touchless bathroom fixtures, self-opening doors and common areas that allow for social distancing. Morris said his firm is even considering adding air purification systems, micro-filtration in the HVAC system and ultraviolet light cleaning procedures.
“All of those building designs had those in there, and now we're just trying to highlight those a little more,” Houston said.
But not every developer is resorting to incentives just yet.
“I don't expect that we're going to do that, but I think you'll have to ask me that question in three or four months,” Gateway Ventures Managing Partner Mack Reese said.
Gateway is developing 8West, a 185K SF loft office building in West Midtown that broke ground on a speculative basis. Reese declined to say how many tenants the firm has been in discussions with, but acknowledged that many leasing decisions are on hold, complicating 8West's lease-up.
Morris said offering more incentives likely won't motivate office tenants to sign leases at this point.
“Changing your incentives doesn't matter when people have a safety concern,” he said. "You first have to eliminate the safety concern."
Developers are holding out hope that the economy returns and leasing resumes long before the deadlines to stabilize their projects arrive. The developers Bisnow spoke to remained optimistic about their prospects as well.
“I think our runway to lease the building up is adequate for the leases that we have. I know that's a hollow answer, but at this point, I don't know if anybody can give you a prediction,” Reese said. “I've been doing this for 35 years, I have not seen an external force like this that's affected everybody.”