Just about everything in an office lease appears to be up for negotiation these days,except a tenant’s rent.
Orange County’s largest office landlords continue to charge increasingly higher lease rates, despite vacancy rates that have inched upward in the past year and the upcoming completion of several office towers, a quick reading of area statistics shows.
The overall asking lease rate for local office space increased 7 cents from the first quarter, and now stands at $2.73 per square foot, according to the latest figures from CB Richard Ellis Group Inc. That’s up 17% from a year ago.
In the area around John Wayne Airport, rates now stand at $2.93 per square foot, up 6 cents from the first quarter.
At the same time, the amount of available office space in the market increased to 14% in the second quarter, up from 12.5% in the previous quarter, according to CB Richard Ellis.
Despite a tougher leasing environment, landlords aren’t cutting rates, according to local brokers. With offices trading hands at a rapid rate, owners want to keep their revenue streams up, to help keep their property values higher.
“As the market starts to soften, landlords are holding on as hard as they can to their inflated rates,” said Royce Sharf, branch manager for the Irvine office of tenant brokerage Studley Inc.
On the bright side, more concessions for tenants are being offered now than in recent years. That includes free rent, moving allowances, furniture and tenant improvement allowances, Sharf said.
A big buzzword in the market today is “beneficial occupancy”,another term for free rent. It’s not unheard of for deals these days to include three to six months of free rent.
Such deals allow landlords of the county’s best offices to keep reporting that they’re charging a high lease rate in the $3 per square foot and higher range,and helps keep the value of their property higher,even though the effective lease rate falls well below that figure.
It’s a good concession for tenants, although the amount of free rent pales in comparison to deals made in other downturns in the office market, such as the late 1980s, brokers said.
Beyond free rent, tenant improvement allowances are seen as the No. 1 incentive being offered these days.
“Tenant improvements are clearly an area open for negotiation,” said Randall Parker, managing director for the Newport Beach office of tenant broker Travers Realty Corp. “It’s a creative way for (landlords) to keep their rents up.”
When the market was tighter a year or two ago, landlords were offering tenant improvement concessions of $10 to $15 per square foot. Now they’re offering up to $25 per square foot for space at existing buildings.
For the area’s new towers, it’s a different story. Typical tenant improvement work can cost anywhere from $40 to $50 per square foot for building out the shells of new office tower properties, Parker said.
To build out higher-end space for a tenant such as a law firm, the costs can go as high as $60 to $70 per square foot.
Those costs are a steep increase from the prices seen in recent years,a result of rising construction costs that have impacted all areas of the commercial construction industry.
“The costs of (tenant improvement) construction are higher today than they’ve ever been,” said John Weiner, who markets a number of the county’s high-rises as a senior vice president for CB Richard Ellis in Newport Beach. “Tenants are asking for the same amount of work,but the costs keep going up.”
Landlords are generally willing to pay about three-quarters of that cost, brokers said, an increase from prior years. That still leaves tenants with a considerable added cost to cover, which often isn’t factored into their initial projections.
“It can make a big difference in a transaction. Tenants really need to understand their true costs,” Parker said.
“The allowances are going up, but it’s still not sufficient to match the increase in construction costs,” Sharf said.
The result is that many tenants prefer to stay put in their existing offices with renewals, rather than move to a new space, he said.
Rising tenant improvement costs aren’t being ignored by landlords either. The increasing costs of construction work are making landlords re-evaluate their strategies at existing properties, said Greg May, senior vice president for the Newport Beach-based office of Grubb & Ellis Co.
“There’s not as much demolishing of existing space” when there’s tenant turnover at buildings, May said. Landlords are working harder to retain existing improvement features, and work around them, he said.
“Landlords are having a hard time (justifying the costs of) retrofitting old space,” May said. “They’ll do (a wholesale renovation) if it makes sense, but it depends on the space.”
