LET’S MAKE A DEAL
By MATHEW PADILLA
Landlords have offered brokers everything from Nordstrom gift certificates to a free Harley-Davidson to lure them and the tenants they represent amid an ongoing office market slump.
Orange County’s office vacancy rate of 16.4% is expected to linger on at least until the end of this year or beginning of next.
Cushman & Wakefield Inc. predicts that office rental rates will continue to decline in the John Wayne Airport area and remain flat in other areas for the rest of the year.
It’s still a tenant’s market.
So landlords throw out perks to brokers and offer tenants rental cuts or free rent, at least for the first few months, to close a deal.
“Owners wouldn’t offer them (perks), if they didn’t work,” said Steven Case, senior managing director of CB Richard Ellis Inc. Case is CB’s top officer in OC.
Case said landlords weigh the benefits and ethical implications of offering perks.
In the end, what motivates landlords to offer incentives is the desire to make sure their space stays high on the list of properties that a broker will show his clients.
Higher Vacancies
Naturally, perk phenomena is most acute where vacancies are the highest: think the John Wayne Airport area and South County. Office vacancy in the airport area is 18.1% and in South County it’s 18.3%, according to Cushman’s first quarter report.
Some landlords have raised their broker commissions from 4% to 5%, according to Chris Deason, vice president with the Irvine office of Voit Commercial Brokerage. Deason primarily handles office lease deals in the airport area.
He said a few landlords guarantee to pay the broker’s commission within 48 hours of closing a deal.
Normally, landlords pay 50% of the commission when the contract is signed and the other half when the tenant occupies the space, Deason said.
Deason said he knows of one landlord that offered a free Harley-Davidson to any broker who could bring in a tenant to lease an entire floor. He declined to name the landlord.
The rain of favors has fallen on brokers and tenants alike.
OC landlords can be broken down into two groups with different strategies, according to Thomas Murphy, vice president and leasing director with Jones Lang LaSalle Inc.
Murphy said one group of landlords, mainly real estate investment trusts, such as Equity Office Properties Trust, are willing to lower rents to attract tenants. Real estate investment trusts focus more on occupancy than rental rates.
Another group of landlords, such as Costa Mesa-based C.J. Segerstrom & Sons LLC, might offer free rent or an increase in tenant improvement funds, but they avoid lowering rents, Murphy said. These landlords concentrate on building equity for a possible future sale or refinance.
Brokers are careful not to give specific examples of deals involving free rent or special tenant improvement funds, since landlords don’t want other potential tenants to know what a great deal the last guy got.
The idea of free rent has been popular with some landlords in submarkets with high office vacancies, such as the John Wayne Airport area, brokers said.
Free Rent
In the case of free rent, the tenant can occupy a building for a few months,typically from two to four months,without paying rent.
This tactic benefits the landlord who wants to sell or refinance the building at a later date, since the tenant will be locked in at a higher rental rate than if it gets a rate cut in lieu of free rent.
CB’s Case said the practice of free rent appeared in the late ’80s and early ’90s in OC, but disappeared when the market picked up in the mid to late ’90s.
Now it’s back.
Tenants also are granted more latitude to use tenant improvement funds towards moving expenses, according to Voit’s Deason.
He said that in a stronger office market landlords insist that tenant improvement funds be used on fixtures, such as carpeting, kitchen improvements, lighting and painting.
But now even smaller tenants are able to use a small percentage of the improvement funds toward moving and cabling.
With rates lower, tenants and landlords are at odds over the length of rental contracts, brokers say.
Tenants want five to 10 years, and landlords don’t want to go beyond three years. Much depends on the clout of the tenant, brokers say.
While some brokers say the future of OC’s office leasing market looks good, others expect bad times to continue into next year.
Jones Lang’s Murphy, who leases two class A towers at Newport Gateway, said this year he’s seen an uptick in potential tenants interested in seeing the property.
“To do more deals, you have to have more showings,” Murphy said. “That’s the first step.”
The market could begin its comeback by the end of this year, according to Jerry Holdner, Voit’s vice president of market research.
But Cushman & Wakefield’s report on the first quarter showed that office rental rates continued to decline, sliding to $2 per square foot per month, three pennies less than in the fourth quarter.
And rates will continue to decline for the remainder of this year, according to Greg Brown, senior director at Cushman, at least in the John Wayne Airport area. Brown said rental rates in other submarkets will remain flat.
Brown and other brokers are concerned about mortgage companies, which have fueled absorption of office space countywide in the past year.
Mortgage lenders taking space last year included Option One Mortgage, part of H & R; Block Inc., which leased 246,324 square feet in Irvine. Orange-based Ameriquest Mort-gage Co., a subprime lender, leased 138,600 square feet in Orange in the second quarter.
Meanwhile, Irvine-based New Century Financial Corp. took 62,850 square feet in Irvine and BNC Mortgage Inc. leased 63,000 square feet of space at 1901 Main St., also in Irvine.
If interests rates rise, borrowing for mortgage would likely fall, hurting those lenders that rely on loan volume to generate revenue. Smaller mortgage lenders could fold.
Of course, if interest rates rise, the economy will likely be improving, which should bring Corporate America back into the real estate game, finally.
