‘You're Going To Have To Pay’: Concessions Rise As Landlords Compete For Office Tenants
Tenants’ upper hand in Houston’s office market is only getting stronger since the onset of the pandemic.
With a rise in construction costs and delivery of new buildings since 2020, some submarkets and asset classes are seeing record-high offerings of tenant concessions, including lengthy free rent and generous construction allowances.
Add in high levels of distress and the ongoing flight-to-quality trend, and brokers are also seeing novel giveaways like build-outs for small office spaces on short-term leases and previously unheard-of assurances that landlords will prove they can fund improvements by handing over financials, they told Bisnow.
Class-A tenant improvement allowances and average number of months of free rent hit new highs following the 2015-2016 oil bust and have continued climbing due to the fading fortunes of office properties, Avison Young reported in its third-quarter office report. Among Class-A spaces this year, the average number of months of free rent was up to 14, and tenant improvement allowance averages were at $68 per SF, the report shows — their highest point in a decade.
Since then, concessions have spiked further, said Dan Boyles, a partner specializing in office tenant representation for Partners Real Estate. Boyles is seeing new lessees securing tenant improvement allowances of between $80 per SF to over $100 per SF.
Houston’s office market saw a record-high vacancy rate at 26.4% last quarter, according to the Avison Young report, which concluded that competitive concession packages have also resulted in lower net effective rents. Net effective rents are hovering around $30 per SF, down from between $33 and $34 in 2019.
What is happening in Houston’s office market is reflective of the national market, French said, adding the issue is submarket- and building-specific. For example, at Texas Tower, a new, premier building in Houston, concessions have been driven up because parts of the building are in shell condition.
“Of course you're going to have higher concessions, it's going to cost a lot more to build them out,” French said. “The cost of construction, too, is feeding into the cost of concessions going up.”
Among A-minus, B-plus offices with good occupancies, by contrast, landlords are offering steep concessions just to make long-term deals happen, she said.
Nirav Shah, CEO of Houston-based landlord Tenant Managers, said tenant concessions are expected in the current environment, and his firm is offering about one month free for every year of a lease.
“Tenants are asking for that and we’re giving that,” he said.
Tenant Managers entered the office landlord space at the start of the pandemic by purchasing 1980s-era buildings.
“I've seen some landlords that have spaces in such bad condition that they won’t even try to lease it in today's market,” Boyles said. “If you’re going to have negative [net effective rent], you’re not going to do it. But if you’re putting dollars in, you’re also hoping that you can use those dollars down the road.”
Investing wisely means a build-out can last long enough to be used by multiple tenants, he said. And in a competitive environment, offering free rent is an important tool in securing safe, long-term tenants.
“If you want them, you're going to have to pay for them. And if you don't do it, someone is going to do it,” Shah said.
Landlords in older markets like The Galleria have to compete so heavily, they are essentially bidding amongst themselves on tenant activity as traffic gallops to newer product, Boyles said.
“There's plenty of space for tenants to lease, it’s just space that tenants don't want to lease,” he said.
To address that, landlords are building out high-quality spec suites in small 2K SF to 5K SF spaces to secure leases of just three to five years, in sharp contrast to past downturns in the office market, Boyles said.
“They’ll spend $80 a foot on build-out to have the space ready … and they will typically do shorter-term leases on it,” Boyles said. “That’s something that is different. In fact, the tenants are getting kind of backdoor concessions because they’re doing a short-term lease with much higher-end build-outs.”
Buildings under pressure, either by having a loan maturing or battling low occupancy, are hamstrung in their ability to offer much when it comes to concessions, French said.
“In fact, their lender may say, ‘No, we're not doing that deal,’” she said.
But even for relatively problem-free buildings, French is seeing tenants asking to check landlords’ financials to ensure they have the capital to fund the improvements they are promising, she said. That maneuver is a career-first for her. Some are also factoring offset rights into their lease agreements, allowing them to defer rent if improvements aren't funded, she said.
Partners is among those advising clients to ensure their concessions are covered, Boyles said.
“We're having to navigate a world that is not just ‘Hey, go out there and negotiate the best deal with the building,’” he said. “We really need to have an understanding of who the landlord is, what kind of debt obligations they have.”
It’s a tenants’ market for the foreseeable future, French said — at least until the reset button is pushed.
“Once the market resets, properties retrade and people have the right spaces … I think the market will change,” Shah said.
Concessions will change along with it, he said, although “if you have a good tenant, you’d be foolish not to cut a deal with them.”