The down office market and an ongoing rough credit environment continue to impact the way Orange County’s landlords and tenants approach leasing concessions.
They’re also causing interior design and construction companies to alter the way they go about their work in order to land new business for their landlord partners, local officials say.
Competition for tenants is “extremely fierce,” said Rick Shlemmer, principal for Newport Beach-based design and architecture firm Shlemmer + Algaze + Associates.
The company, which also has an office in Los Angeles, is tracking about 110 potential large tenant leads in Los Angeles and another 65 or so leads in OC.
Tenants in the market for new space typically may be interested in seven or so offices when beginning their search. Those companies and their brokers quickly narrow their selection down to about four spaces after an initial study of the buildings.
Architectural firms such as SAA that work with landlords to design office space for tenants in their buildings are increasingly being relied on to help make a great first impression for office space, said Shlemmer.
“From our standpoint, the attitude is that the minute we get the call (from a landlord), we have to jump on it,” said Shlemmer. “They’re asking us to (help make it past) that first cut.”
That’s a departure from traditional interior design work when companies tailor office suites for a specific company after it has agreed to be a tenant.
Concessions
More presentable raw space isn’t the only thing landlords are doing to attract tenants.
On a whole, concessions offered to tenants,including free rent and tenant improvement packages,are increasing.
At the end of the first quarter, the average tenant improvement allowance for a tenant leasing less than 50,000 square feet at one of OC’s best offices was about $35 per square foot. For tenants taking more than 50,000 square feet, an allowance of $50 per square foot is the norm, according to the Irvine office of brokerage Studley Inc.
At the end of 2007, tenant improvement allowances were closer to $20 per square foot for smaller tenants and $35 per square foot for larger ones, according to Studley.
Similar effects are being felt across the country.
Officials for Newport Beach’s KBS Real Estate Investment Trust said last month that in order to keep its national portfolio of offices, which totals about 21 million square feet, occupied at levels close to 92%, it’s been increasing tenant concessions, including three or more months of free rent.
That’s begun to impact cash flow, officials said. It caused the non-traded REIT, one of several investment programs overseen by KBS Realty Advisors LLC, to cut back shareholder distributions this summer.
The moves will pay off in the long run when those offices are sold, according to Chief Executive Chuck Schreiber.
The “high occupancy level will be very beneficial for the assets in the future and should contribute to achieving a premium in the sale price when we sell these properties,” Schreiber said in a letter to shareholders last month.
While tenant improvement allowances are up, not all OC landlords are able to fund the deals. Transactions are increasingly being directed to better-funded, cash-flush landlords with fewer debt issues, brokers say.
That’s keeping some prominent area buildings owned by under-fire landlords from grabbing new tenants,and further depressing the prices of many of those same buildings.
OC could begin to see the creation of a class of haves and class of have-nots among landlords, according to tenant brokers. New owners who’ve bought distressed properties in recent months at substantial discounts should be able to outbid those competitors who are facing debt issues for building acquisitions financed at the peak of the market.
In addition to difficulties in finding the money to provide allowances, troubled landlords are more likely to tighten their standards for providing an allowance, or they may ask a tenant to provide the capital for space improvement themselves.
Deep Pockets
Emmes Group of Cos. structured last month’s purchase of the 3161 Michelson office tower at the Park Place campus to assure itself that there’d be plenty of funds available for generous tenant improvement allowances, according to Richard Coles, co-managing principal for the New York-based investor.
The company last month paid about $160 million for the 531,000-square-foot tower, which was built in 2007 by Los Angeles-based Maguire Properties Inc. and is about 50% full. That sale price was about 40% below the building’s construction cost.
For a trophy property such as Irvine’s 3161 Michelson office tower, where some top-floor tenants are reportedly paying monthly rents close to $4 per square foot for space, pricey tenant improvement work is expected before companies move in.
Coles said that Emmes is committed to providing high-end services to both new and existing tenants, and it will invest the necessary amount of money to keep the building quality.
The 19-story tower’s purchase last month was financed with a $120 million loan from lenders led by Eurohypo AG, which owns the construction loan.
Other new owners in the area also say they’ve got the deep pockets needed to land tenants.
Long Beach’s Abbey Co., the new owner of Orange’s City Parkway office complex, has established a “substantial budget” for capital improvements and leasing expenses for the property, according to Chief Operating Officer Thomas Clarke.
The company last month bought the 457,000-square-foot property for an undisclosed price from Maguire. The building stood at about 30% full at the end of the first quarter. A few years ago the buildings had been leased to the parent of subprime lender Ameriquest Mortgage Co., which went out of business.
Abbey said it is expecting to fork over solid money to make the building appealing to major tenants in this market.
This puts different pressure on tenant improvement companies to make sure their work appeals to both the tenant’s preferences and the landlord’s pocketbook.
“We have to understand the deal points,” Shlemmer said.
Often, that means upgrading space at a cost below the norms of a few years ago, he said.
