Confidential: For CRE Landlord’s Eyes Only

confidentialIt is a simple fact the commercial real estate rental space will take longer on average to lease than a residential suite.  After a commercial rental unit (cru) has been on the market for a period of time a discussion should take place between the Broker and Vendor exploring potential reasons.

There are many factors that can contribute to a lack of success in locating a suitable Tenant.  Has the space been properly marketed, does it require updating, refreshing (You only get one chance to make a first impression) or demolition of obsolescent improvements, would rental incentives such as free rent or a Tenant improvement allowance be appropriate, etc.  One of the questions that needs to be a part of that discussion: is a price adjustment required? There isn’t necessarily a simple answer to that question however we’ll explore how that discussion might look.

What do the comps say?

A regular review of the details of recent, completed lease transactions and the current asking rates of comparable property is required to make an educated pricing decision. I have witnessed markets where vacancy has slowly grown over a period of time without significant price fluctuation. A change can happen quite rapidly however when 2 or 3 landlords have decided they have been carrying the property too long and choose to drop their price to secure a deal. When that takes place, it can have a real effect on the rest of the market.

Could a pricing decision affect future negotiations?

Let’s say I reduce my list price on a cru to a number which is less than what a Tenant in the next bay is currently paying.  You can guess what will happen when I try and negotiate a lease renewal with that adjacent Tenant. A Landlord has to assume that the lease terms negotiated with a new Tenant may at some point be disclosed to an existing Tenant.  Again, I don’t have to tell you what the potential impact of that disclosure in negotiating with the new Tenant is if he has dropped his rate considerably.

How does a pricing decision affect value of the asset?

There are three primary methods of calculating the value of commercial real estate.  They are: the income approach, cost replacement method and comparable approach.  To calculate the market value within the income approach, the net rental rates are applied to a capitalization rate.  If a Landlord has a goal to either sell or place a mortgage on his commercial real estate, it may be therefore beneficial to wait for a slow market to subside.

If you are currently a Tenant or plan to lease space in the future and have read this article in spite of the title, you now have a better understanding why Landlords will often prefer to have their building sit vacant.

Posted by Barry Stuart

 

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