By David Marino

Three and a half years post-COVID, and it’s universally understood that office commercial real estate is in crisis. Office vacancy rates have gone up 50% nationally due to companies downsizing as their leases expire and they implement remote working and hybrid work models. Yet national average asking rents for office space have not gone down… not by a single percentage point. Name one commodity where the supply of that good or service has gone up 50%, yet the price is unchanged. Think about it… gold, oil, soybeans, automobiles, stocks, houses, Beanie Babies, cryptocurrency… not a single one, ever! So how can this be explained that landlords are struggling to lease 50% more office space, yet they haven’t discounted the price one dollar?

Landlords Set the Prices

Early in my career in the mid-90s, the managing partner of one of the largest real estate developers on the West Coast said to me, “Commercial real estate is the last great unregulated industry.” While landlords don’t formally collude, they directly and indirectly share a tremendous amount of information and anchor off each other’s pricing, and that is exactly what’s been happening since COVID began. In March of 2020, building owners got together and held the line on prices, and agreed directly or through their broker community partners, that they were not going to lower prices.

Building owners have good reasons not to lower asking rents as there is no public recording of leases whereby the tenant community ever knows what people are actually paying, or the details of the myriad of concessions that can be negotiated. With the brokerage community largely working for landlords, or frequently acting as dual agents representing both landlords and tenants in the same transactions, landlords have full transparency of what each other are doing in real time. Brokers publish almost every lease transaction within their own internal databases, often as a requirement to getting paid their commission by their firm. Those databases are then shared across their entire brokerage firm, and much of that data is commoditized and traded with other brokers, and generously shared with other landlords these same brokerage firms represent. Tenants’ confidential lease information rarely stays that way for very long, and landlords know who’s doing deals, and at what terms, while the general public and tenants are lured into thinking that prices are the same as they were back in 2020.

Brokers Price Support the Market

I’ve always said that landlords write the music, but the brokerage community are the singers and the band. The role of commercial real estate brokers is to support landlords in their pricing and valuation agendas. You only have to look back historically over a century as to what the brokerage community was created to do. The brokerage business is built on the backs of landlords providing leasing, asset management, property management, investment sales, capital markets, appraisal and any other imaginable service that a building owner might need. Even more than just having landlords as their primary customer, brokerage firms have become landlords themselves by investing billions of dollars directly into billions of square feet of real estate all around the world… all while doing the leasing and management on those same buildings. For example, CBRE directly owns, or acts as the asset manager—a fiduciary relationship of little difference than direct ownership—for nearly 3.5 billion square feet of commercial real estate, making them one of the largest landlords in the world. The flow of tenants became a byproduct of those businesses, and the idea of these full-service brokerage firms representing tenants’ best interests is a farse.

Tenants trying to negotiate their own renewal, using the dual agent landlord-broker or someone on the landlord-broker team, are particularly vulnerable to deception. I remember in 2001 after the dot-com bust that one of the biggest landlords in town hadn’t lowered their asking rents even though pricing was down 20% since the prior year. When I challenged the landlord’s broker to lower prices, he said that they wanted to keep the asking rents up for when a tenant might look to renew or expand that didn’t have a tenant-side independent broker and foolishly thought they were somehow saving a commission by working directly with the landlord or landlord’s broker. They then could give that tenant a 10% discount on the rent, and the tenants felt like it was a pretty good deal. The reality is that we were doing leases in that same building at 20% off the asking price, with big packages of free rent and tenant improvements.

Yes, that man or woman who does the leasing for the building is charming and always knows what’s available, but they aren’t going to betray their core customer—the building owner—to get you, the tenant, the best deal possible. No one is there to test the landlord’s marching orders or whispered bottom line. Worse, the tenant working directly with the landlord or through the landlord’s listing team has no leverage, no legitimate relocation options, and little real information about what can truly be done in that building or elsewhere… particularly in subleases. The commercial real estate industry is completely opaque to a tenant that gets lured into this situation, and brokers are not even thinking about tenants’ interests when conducting these activities. It’s all about monetizing the real estate, which comes down to monetizing the tenants and the associated rent stream—tenants become a means to an end.

The Role of Lenders and Investors

Beyond the players that set prices and support them, there’s a serious structural problem that prevents landlords from just lowering their rents, even if they wanted to. Most commercial real estate buildings have outside investors and debt. Those investors have been promised a certain return and are anchored to their valuation. The lenders are even more married to the pro forma, and it’s not only that there is debt service to pay, but there are loan-to-value ratios to be maintained, and no one wants to mark-to-market office real estate. As a result, landlords simply maintain their pro forma asking rents, but quietly offer bigger tenant improvement allowances, large free rent packages, moving allowances, lease assumptions and other financial concessions that are necessary to keep or win new tenants, without lowering their prices. The financial reality is that landlords and their lenders are better off keeping a space vacant at their asking rents, than seeing the building value go down by doing leases at 20%-30% off their asking rent pricing.

Ultimately, this house of cards does fall down as pre-COVID occupancy rates go from 85%-95% down to 65% or 75% as tenants downsize, go remote, relocate to cheaper options or subleases, and landlords’ occupancy levels erode. Not only has vacancy gone up, but the average time on the market that an office suite sits vacant has gone up 50%-100% in most metro areas. The end result is ultimately receivership and foreclosure, which is now happening regularly across the country. As happened from 1991 to 1995, this begins a death spiral where the declining market causes office building after office building to not be able to meet its debt service and loan-to-value ratios, whereby the real estate ultimately gets foreclosed upon and re-sold at a fraction of replacement cost. The entrepreneur real estate investor that buys that real estate has a new favorable basis, and reprices asking rents to reality versus what all the other landlords are committed to, and soon begins a cycle of real asking rental rate declines. It’s likely that we’re going to see ongoing declines in occupancy for another three to four years as the remaining 50% of leases expire around the United States. That’s going to result in degrading performance of commercial real estate office buildings, which will ultimately result in more foreclosures, and so the cycle goes until we hit some kind of bottom in 2027 or 2028.

What all of this means for tenants is that you can’t believe landlords’ asking prices, nor the brokers that are promoting them, measuring them or using them as a benchmark to push tenants into mediocre leases that tenants should not be signing. The commercial office market is much more favorable to tenants than business owners and executives running companies understand, but you have to get into the market and test your options, including looking at one of the many subleases that likely are available for consideration, to force a process of price discovery, rather than thinking that asking rents are any reflection of the market we are actually in. All of that requires a zealous advocate, that acts only as a tenant’s broker, and doesn’t work for landlords or a full-service brokerage firm helping building owners prop up the asking rents in an office market that’s in collapse.