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Tenant Improvement Allowances Pinched by Stronger Market, Higher Construction Costs



By NIDAL M. IBRAHIM

Declining vacancies and a generally improving office market have landlords pulling back on tenant improvement allowances and other incentives.

Just the same, few people are willing to declare that landlords are now in the driver’s seat.

In the perpetual dance between landlords and tenants, building owners increasingly are taking the lead and being more aggressive in their demands.

Landlords are buoyed by vacancies that have fallen to 10.6% and rents that have risen to $2.05 per square foot per month, according to CB Richard Ellis Group Inc.

Further tightening the office market is the lack of new space under development.

The most obvious place where tenants have lost their negotiating edge has been in tenant improvement allowance packages, said Tom Gibson, principal with Gibson Co., a Newport Beach-based tenant representation company.






No vacancy: Ford Motor’s 265,000-square-foot Irvine building is full

Incentives typically include a specific dollar amount per square foot that tenants can use to improve their office space. Allowances could be new paint or carpeting, or something bigger such as moving walls or reconfiguring the entire space.

“Allowances for tenant improvements have been tightened up considerably,” Gibson said. “It affects both second-generation space,previously occupied space,as well as new shelf space. It’s becoming much more difficult to get the sufficient amount of dollars to improve the space for tenants than it was several years ago.”

Spiraling construction and labor costs have become a big factor on the tenant improvement scene.

Higher steel prices have drawn plenty of media attention, but the price of drywall, lumber and other construction materials also has jumped dramatically during the past several years.

The higher costs have come amid a boom in home remodeling and renovation. Framers, plumbers, drywall contractors and other laborers are in high demand and have priced their work accordingly.

Bill Halford, president of The Irvine Company’s office properties unit, sees landlords continuing to improve their hand.

“Over the last year, with the amount of net absorption that has occurred and the resulting drop in vacancy, the dynamics are clearly shifting in the marketplace,” said Halford, who oversees the Irvine Co.’s estimated 29 million square feet of office and retail space. “Last year and the year prior, when vacancy was relatively high and landlords were in more of a chase mode with tenants you saw many landlords offering free rent as part of concession packages. I think we’ve seen that diminish in the marketplace to being a very unusual concession, if not nonexistent.”

Still, Halford shies away from declaring this a landlord’s market,despite his portfolio’s more than 90% occupancy rate.

“I believe that this market has gone from an imbalanced market to what I would consider a more balanced market where rents and tenant improvement packages make economic sense to own buildings,” he said. “It’s not the heyday for landlords. It’s a very balanced market.”

The consensus is that if office absorption proves to be as strong this year as it was in 2004, vacancies will continue to dip and lease rates will rise.

Meanwhile, there’s less than 500,000 square feet of office space under construction in OC, according to CoStar Group Inc. Most is being built by Santa Ana title insurer First American Corp.

Possible office development in the future includes Maguire Properties Inc.’s plans for a 20-story, 600,000-square-foot tower at its sprawling Park Place office campus at the corner of Jamboree Road and Michelson Drive. New Century Financial Corp. is set to move its headquarters to the Irvine complex.

Newport Beach-based lender Impac Mortgage Holdings Inc. recently signed a 200,000-square-foot lease for all of a proposed seven-story building on Jamboree near Fairchild Road in Irvine.

Packing company Scholle Corp., which has its headquarters at the site, plans a 450,000-square-foot office park there.

Fort Worth, Texas-based Crescent Real Estate Equities Co. is set to buy land at Michelson and Von Karman Avenue, entitled for 271,727 square feet of office space. Crescent has an eye to develop a 12-story office building.

And the Irvine Co. has announced plans to build some 950,000 square feet of office space. Most of that space is set for its University Research Park complex. Chipmaker Broadcom Corp. plans to move its headquarters to the site.

None of the projects are expected to finish in 2005.

Despite the gains landlords have made in the past year, Royce Sharf believes tenants still can hold the line on some issues.

Sharf, executive vice president with Studley Inc. in Irvine, believes the right tenant still can dictate some terms.

“There’s a lot of theoretical discussion of pressure on the market that should manifest itself on increasing rates and decreasing concessions. But to date, anyway, we haven’t seen any kind of appreciable move in that direction. Both sides of the table expect it to happen, but it has not yet markedly expressed itself.”

Sharf said tenants Studley represents haven’t seen improvement packages shrink compared to past. The pinch, he said, has come in that the incentives haven’t kept up with increasing costs.

“The tenant improvement packages remain fairly healthy,” he said. “One interesting thing is the cost of construction has increased dramatically for a number of reasons and TI packages have not increased commensurately to that cost of construction.”

Those costs are up 25% to 35% since early 2003, Sharf said.

Studley officials are trying to get some clients to lock in leases before they see higher asking rents from landlords.

“Now is probably a healthy time to secure longer term occupancy,” Sharf said. “We don’t expect that rates will continue to stay as favorable as they are today.”

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