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Five Tips to Ease the Pain of Rising Rental Rates

Rental rates are on the rise. If you’re leasing commercial space, consider these creative ways to help reduce occupancy costs and enhance your bottom line.

Commercial real estate has rebounded in most parts of San Diego County. So much so that it has been on a tear in the Class A office space arena during the last 18 months, with rents spiking between 25-40%.

Class B office space was the place to shop in the last 24 months. Well, guess what? Rents are rising in Class B office space too. Asking rental rates for Class B office space in San Diego have ticked up around 20-35%. Tenants paying $1.50/SF are now being asking to pay $2.25/SF.

Beware sticker shock! It’s the trickle down effect. As in any supply and demand scenario, the good stuff goes first. Class A is leased up first. Now Class B is in demand, so rates are on the rise.

Class A office space in San Diego County submarkets such as Carlsbad, Del Mar Heights, the I-15 corridor, and Sorrento Mesa is running in the single digit to low double-digit vacancy rates compared to 25%+ 18-36 months ago. These same submarkets have Class B vacancy rates in the 13% range, compared to 12 months ago when vacancy rates topped nearly 30% in some areas.

The industrial and R&D markets around the county also show signs of spiking rental rates, which have climbed roughly 20%. And biotech real estate has soared almost comparatively with Class A office rents.

In spite of rental rates increasing, here are some tips to help ease the pain:

1. Relocation

Landlords want to obtain their rental rate as it directly correlates with their building value. Understand this, and start to push on other concession areas, such as increasing free rent or tenant improvement allowances, with the option to apply the unused portion of the allowance towards rent.

2. Subleases

While scarcer than they were 24 months ago, they still exist. Subleases can be a great way to capitalize on market conditions. Sub-landlords are not looking to add real estate value, rather mitigate their costs. Therefore, they are able to be much more competitive than direct available space.

3. Phase In

While landlords will always want to obtain a higher rental rate, try to negotiate a phase-in for new space. In other words, if you desire to lease 10,000 square feet, perhaps you can negotiate paying only on 8,000 square feet during the first 12 months. Understand that, in doing such, a longer lease term will most likely be required such as 5 years or more.

4. Different Building Class

Instead of looking at leasing Class B or Class A office space, locate a fully improved flex building for a lesser cost. Instead of paying $2.25/SF for a Class B building, locate a flex building that is mostly improved for 50 cents less per square foot. This does come with compromises – for instance, the glass line will be limited compared with traditional office space. However it can help you meet your economic objectives.

5. 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 secure a tenant is fierce, which enhances leverage for renewing tenants. Quite simply, tenants who renew can extract more of their landlord’s renewal profits. A renewal is the most profitable transaction for any landlord, and it typically will cost a landlord 2-4 times more in capital to lose a tenant compared with securing a replacement tenant.

As rental rates are rapidly increasing, it is important to prepare a game plan for the next 24-36 months for companies who lease commercial space. Now is the time to start thinking about how to, not only reduce occupancy costs, but also enhance the bottom line by finding creative ways to capitalize 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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