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Commercial Real Estate Market Rebound?

Is the commercial real estate market headed for a rebound? Not yet. The glut of office space dumped on the market by the financial and residential real estate sectors, scarce tenant lease rollover for the next year, and newly built office buildings during recent times have pummeled space demand. Rental rates have long been inflated due to investors overpaying for real property, and the disparity between demand for space and artificially rising rental rates finally gets a gut check. Increasing tenant concessions, mostly in the form of free rent, is the most common tactic by building owners to shore up vacant space.

San Diego sub-markets with the highest office vacancy rates are Carlsbad, Del Mar Heights, and Sorrento Mesa with 23%, 15%, and 14% respectively. Vacancies along the I-15 Corridor, Mission Valley and Kearny Mesa are also on the rise compared to 12 months ago. The industrial and flex markets around the county also suffer from an increase in vacancy, but nothing compared to the spikes in office product. Furthermore, available office space sits on the market about 20 months until leased. While it is not apparent the office market will plummet back to the implosion of the dot-com days, it is almost certain it will take another 18-24 months until equilibrium is reached.

In spite of the office real estate market in its downward state, most San Diego companies who are outside the financial or real estate industry seem to be doing quite well. Companies who are financially stable during this period have an opportunity to capitalize on occupancy cost saving strategies in one of the following ways:

1. Relocation

Tenants who need to relocate are not only negotiating greater free rent periods, but also increased improvement allowances, reimbursement of moving costs and basic IT infrastructure. In addition, subleases can be a great way to capitalize on market conditions. Sublandlords are not looking to add real estate value, rather to mitigate their costs. Therefore, they are able to be much more competitive than direct available space.

2. Lease Renewal

Businesses who have a lease expiring in the next 12-18 months are at the onset of their real estate strategy process. Even if the objective is to renew the existing lease, savvy tenants will strategize and deploy tactics far in advance of the expiration date. Competition amongst landlords to lease vacant space is fierce which enhances leverage for renewing tenants. Quite simply, tenants who renew can extract more of their landlord’s renewal profits.

3. Lease Re-Structure

Why not refinance your lease? Tenants with less than 50% of lease term remaining and a termination date within the period of years 2010 to 2011 may be able to benefit from a lease restructure and immediately reduce occupancy costs. Overpaying tenants can reduce their rental rate now versus negotiating a renewal when the market has stabilized. Other benefits of this strategy include receiving tenant improvement dollars early, readjusting operating expenses, and adding or decreasing physical space. A simple concept, but one that takes time and proper planning. Most landlords do not desire to reduce their fixed income stream in the middle of a lease term. Therefore, certain factors and tactics must be understood and deployed in this situation to make it an effective economic scenario.

Until recently, landlords were slow to adopt the rate reduction model but offered free rent as a way to secure tenants hunting in the open market. As rental rates are now showing signs of decline and as other tenant economic concessions increase, it is important to prepare a game plan for the next 24-36 months for those who lease commercial space. Now is the time to start thinking about proactive ways that not only reduce occupancy costs but also enhance the bottom line by capitalizing on current market conditions.

Scot Ginsburg is a senior vice president of Hughes Marino, an award-winning commercial real estate company specializing in tenant representation and building purchases with offices across the nation. Contact Scot at 1-844-662-6635 or scot.ginsburg@hughesmarino.com to learn more.

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