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Landlords Boosting Tenant Concession Packages As Market Swings In Tenants' Favor

The national office market is suspended in midair, and few landlords or tenants want to sign deals. But behind the scenes, some parties are negotiating, and property owners are showing a willingness to greatly expand tenant improvement allowances and rent abatements, office brokers say.

It’s a sign that when the office market does reignite, tenants will find themselves in a historically advantageous position and can look forward to securing leases that will greatly boost their bottom lines with months of free rent and funds to renovate new offices.

“It’s already happening,” Chicago-based Savills Vice Chairman Lisa Davidson said. “But if I were a landlord, I wouldn’t want to be shouting about it.”

Downtown view of the New York skyline from One Manhattan West

There isn’t much data available in many markets, and it will take time before the true picture comes into focus, she added. Right now, with so many downtowns almost entirely empty and no one certain how or when vaccination campaigns will make offices safe again, or how lingering fears of COVID-19 will impact demand for space, inking deals seems risky.

“Nobody wants to be first to the table,” Davidson said. “And there is nothing pressing tenants to make a decision, because their backup plan is just to work from home and get short-term lease extensions. A solid majority are just waiting until it’s very clear that by a certain date everyone is going to be vaccinated.”

“It’s not like people are clamoring for space,” EnTrust Realty Advisors Managing Director Gloria Materre said. “And now, with the new COVID strain, people are going to be even more reluctant to rush back.”

“Repeatedly, I hear people say, ‘we’re in a wait-and-see mode,’” according to Joe Brady, CEO of the Americas at flexible workspace company The Instant Group.

Leasing activity in Downtown Chicago totaled about 500K SF in Q4 2020, according to Savills data, down from around 2.8M SF in Q4 2019.  

The likely direction of tenants’ concessions package is a bit clearer in more active markets. Unlike Chicago, New York City is a destination for big tech firms, which buoyed its office market even in the face of the coronavirus pandemic, according to Newmark Vice Chairman Ben Shapiro, and he already sees a possible trend.

“What we have seen is a significant increase in concessions,” he said.

Rental rates have only ticked down a few percentage points, Shapiro added, but landlords seem willing to do a lot more on the concessions side to keep buildings leased. He estimates total tenant concessions are up 25% to 30% in New York City when compared to the pre-pandemic market, roughly split between rent abatement and other tenant improvement concessions like allowances for furniture.

The average tenant improvement allowance for Manhattan leases of more than five years increased from $84.66 in 2019 to $101.58 in 2020, a nearly 20% boost, according to Colliers International. And the average amount of free rent went from 10.5 months to 11.7, the firm found. The average rental rate in Q4 2020 sank to $74.39, a 5.5% decline from Q4 2019.

Shapiro said Newmark is working with a firm that wants Class-A space in Midtown Manhattan. The firm began hunting before the pandemic, then put the decision off for a while, but it is now confident enough to start looking again. And of the half-dozen or so buildings Newmark engaged both before and during the pandemic, landlords were willing to boost concessions by an average of 21%, he said. 

Savills' Lisa Davidson

But it’s hard to predict whether such approaches will continue, Shapiro said. So far, even in markets like New York where tech giants like Amazon, Microsoft, Google and Facebook are expanding, there is still a relatively small number of recently signed leases. And once tenants start flooding back and demand picks up, landlords may decide they no longer need to offer big concession packages.

“It’s challenging because the data points are few and far between,” Shapiro said.

Tenants leased 4.2M SF in Manhattan in Q4, according to Colliers International. That’s a 68% decline from Q4 2019.

Still, even if the majority of tenants have decided to hold off on actually signing new deals until they can bring their employees back to the office, there is a lot of chatter in many markets between owners and tenants over possible concession packages.

“The volume of planning is way up, and we think that’s a harbinger of things to come,” Denver-based Newmark Senior Managing Director Andrew Blaustein said. 

Davidson said the same kind of talks are going on in the Chicago market. She doesn’t expect robust leasing velocity in Chicago to return until 2022. But there are a few tenants out on the market, and as long as they’re serious about signing a lease and have good credit, landlords are willing to set aside the usual wait-and-see attitude.

“Tenants don’t have to sign long-term leases to be taken seriously,” she said. “It’s more that they simply have to be ready to commit to something for more than a year. So even on three- and five-year leases, rents are down and concessions are up.”

And it’s not just landlords of Class-A buildings that are willing to be generous if it means getting buildings filled.

“It’s not about the type of building,” Davidson said. “It’s any building that has a significant amount of vacancy. And that list is growing every day.”  

In some ongoing negotiations in Chicago, landlords and tenants are talking about tenant improvement packages of at least $120 per SF, numbers which could go higher if tenants meet other demands such as agreeing to longer lease terms.

The average tenant improvement package for Downtown Chicago in Q4 2019, just prior to the pandemic, was a little more than $93 per SF, according to a 2020 Savills analysis of CompStak data.   

“It’s not like a $120 package was never heard of, and you could name a couple of buildings that did it, but it’s becoming more common,” she added.

Eighteen months of gross free rent is no longer out of the question, at least for owners looking to fill newly constructed space with top tenants willing to sign long-term leases, she said.

Tenant broker Materre has a couple of deals cooking in the Chicagoland market. She can’t share any details because the negotiations aren’t yet public, but for deals that in pre-pandemic days would usually result in tenants getting a few months of free rent, Materre senses a willingness among landlords to go much further toward tenant demands.

“I’ve even asked for a year of rent abatement, and they may balk at that, but to get a deal done they may negotiate with you,” she said.

An advanced air filtration system

Even when the office market returns to health, tenant concession packages larger than in the pre-pandemic era could become the norm, according to Shapiro. All the talk going on behind the scenes about concessions has raised expectations among tenants about what’s possible.

“It’s a hard thing to ratchet down,” he said.

With millions of square feet of sublease space being added to markets around the U.S., including in New York, Chicago and Dallas, tenants may have an unprecedented ability to play landlords against one another, according to The Instant Group’s Brady.

“It has the potential to be a really ugly situation for landlords,” he said.

But before deal activity can accelerate, obstacles need to be removed, Brady added. The inauguration this week of President Joe Biden may boost market confidence by removing some of the political uncertainty hovering over the U.S., he said. There’s still the pandemic and the possibility of more civil unrest to worry about, but if vaccinations ramp up, office users may finally start to think seriously about the future.

“In February, March and April, we could start seeing corporates make strategic decisions,” he said.   

There are landlords ready to draw the line when it comes to giving out generous concessions. The need to make employees feel safe led some owners to spend millions on high-tech air filtration systems, doors operated by touchless technology, sensors that can detect pathogens and other safety steps, and they feel that should be sufficient to attract tenants.    

“There is upward pressure on incentive packages to retain tenants or secure new leases, but we’ve done a lot of things to make sure our building environments are solid, and we think there is going to be robust demand for such buildings, and that they will be in short supply,” Riverside Investment & Development Executive Vice President Kent Swanson said.  

His Chicago-based development firm completed 150 North Riverside Plaza, a 51-story tower in Chicago’s West Loop, in 2017, recently finished the Bank of America Tower at 110 North Wacker Drive and is building the BMO Tower, a 46-story tower at 320 South Canal St. Swanson has an office in 150 North Riverside.

“I have an app on my phone that allows me to check eight or nine different variables on air quality,” he said.

Swanson and other tenants can tell if pathogens or other impurities are present, he added. All three buildings have these features, as well as touchless entries, antimicrobial coated surfaces, direct-dispatch elevators that allow riders to socially distance without increases in waiting or travel times and advanced HVAC systems.

“Not every Class-A tower is spending the money we’re spending and doing the things we’re doing,” Swanson said.