Thinking through COVID related lease renewals for your commercial properties
It’s been seven months since COVID-19 invaded our lives and consciousness. All of us have been affected in one way or another.
Many commercial real estate investors are experiencing significantly reduced income from their properties. Tenants are struggling to pay their rent, and the government is facing a stalemate in regard to new stimulus funds. Cities, counties, and states are quickly running out of money and will be scrambling much like many businesses are today. PPP and other state and federal programs were helpful, but for many small businesses those funds have run out. COVID-19 still exists and is being battled in all 50 states. Even with a vaccine, unknown challenges still lie ahead.
Currently, unemployment in Oregon is hovering at the 10.4% range, up from 3.5% in March of this year. There are approximately 170,000 open claims as of August 29th. This is an indicator of a challenging economy.
More importantly, in most of the State of Oregon, the Governor has limited interpersonal contact, which means that in the populated parts of the state (the Portland metro counties) people are not returning to offices and retailers are facing special rules that limit the use of space we are leasing to them. Even with these restrictions, we are currently collecting close to 90% of the rent in our management portfolio. But the writing is on the wall; over the coming year many tenants will either be shrinking their leased spaces, closing their businesses, or not renewing their current leases, especially in the office, entertainment, restaurant, and food sectors. Statistics for this have not been assembled yet.
Many of our clients are being forced to consider four significant changes to the marketplace in order to compete for tenancies and/or fill vacant spaces.
They are the following:
- Commissions: Landlords will increasingly be expected to pay procuring brokers a greater of full fee (commission). In other words, those brokers that control tenants can charge a premium to deliver a tenant to your building. Typically, an office transaction would see total fees increase from 5 to 7.5% and a retail deal would see increases in fees from 6 to 9%. In both cases, the broker that is providing the tenant will be getting paid a full fee.
- Tenant Improvements: New Tenants will request and expect no less than $30 a foot, often $50 a foot in tenant improvement allowances plus free rent to make a deal. Tenants may agree to extend their leases to six and possibly seven years to justify these tenant improvements.
- Reduced Rents: Due to the influx of increased commercial inventory, we expect lease rate compression. This will express itself with rent reductions of up to 20% or more.
- Negotiations with Existing Tenants: It is time to consider giving tenants in verifiable financial troublesome form of rent concession, to help them over the short-term hump of lowered income and increase the likelihood they will renew with you. It is our position that we need to be planning now for the summer of 2021. COVID vaccinations will not be on the market until then and fear, worry, and infections will keep tenants and their employees at home. Consider this: you can either pay more commissions and new TI expenses or keep your existing tenant by agreeing to lease concessions.
Investors need to make pragmatic decisions now to avoid twelve or more months of vacancy. They also need to be prepared to pay more for obtaining new tenants.
In the next year, expect to lose tenants from some of your commercial buildings as leases expire and businesses make the decision to allow their employees to work from home. Now is the time to plan ahead and consider making decisions for the long term and not the short term. In other words, work with your existing tenants to help them stay in business through this pandemic.
That being said, some business owners were hanging on by a thread before the pandemic. They were thrown a life preserver with the PPP funds, but have a hard time running a successful business. It may be better to let them go out of business to allow a more successful business to eventually take its place. Take the time to request and review business financials for the past 24 months before you make any decisions. Get advice from your CPA, your property manager, or accounting friends with finance degrees to confirm you are making the best leasing and renewal decisions for your commercial investment properties.
By Clifford Hockley
President, Bluestone and Hockley Real Estate Services