The Real Deal New York

Office landlords sweetening the deal

To attract tenants, landlords warm to lease takeovers, recognition agreements and concession packages

March 31, 2009
By Adam Pincus

Go to chart: Manhattan office stats

Landlords chasing a limited number of tenants are employing aggressive techniques that were not seen a year ago, but are now being offered to attract companies to their buildings.

The provisions, such as lease takeovers, concession packages and recognition agreements, are growing in importance in the tenant-friendly marketplace.

Michael Gottlieb, a tenant-side broker and executive managing director at full-service real estate firm Grubb & Ellis, said that for the first time in recent years he is seeing building owners consider buyouts of a tenant’s old lease, known as a lease takeover, to induce them to move out of their current location and into their building instead, an investment that would have been unheard of in the tight market last year.

“I have seen a willingness by landlords to consider [lease takeovers] in the past 60 days,” he said, though he has not yet included such a provision in a signed deal.

That willingness, he said, comes as concession packages — generally free rent and tenant improvements — have doubled compared to a year ago. He said that the value of the incentives has shot up from about 7.5 percent of the total leasing package a year ago to as high as 18 percent now.

And to keep space leased up, even at a lower rent, landlords with sublease space are more open to signing agreements that lock in a subtenant’s cheaper rent, said Michael Beyda, president of Times Square-based tenant-representative brokerage Benchmark Properties.

The contract, known as a recognition agreement, allows the tenant to remain in the subleased space in the event of the default of the overtenant, who may be paying a higher rent. While some brokers said such clauses have always been part of their practice, they are paying more attention to them as the possibility of overtenants defaulting increases.

Beyda represented a law firm that signed a seven-year lease in mid-March for 5,000 square feet of sublease space in a Class A building for 15 percent below the overtenant’s price and signed a recognition agreement with the landlord.

“It became a critical point for us in light of the uncertainty in the economy,” he said.

Lloyd Shor, a partner in the real estate development group specializing in landlord-side leasing at law firm Blank Rome, said the financial strength of the building when it comes to vacancy rates, quality of tenancy and loan repayment schedule determines whether a landlord will sign a recognition agreement.

“The more vulnerable a landlord feels as a result of those areas, the more likely it is to give a recognition agreement,” said Shor.

Manhattan leasing activity fell modestly to 910,000 square feet in February, down a fraction from January but still off 31 percent from a year earlier, when 1.32 million square feet was leased, according to the most recent report from real estate services firm CB Richard Ellis.

Similarly, the availability rate, which counts space that is or will become available over the next 12 months, rose in February to 12.5 percent, up 0.2 percentage points from January and up 33 percent from last year, when the figure was 8.3 percent, the CBRE report showed.

Asking rents showed steeper declines in February. They fell to $59.10 per square foot, off 7 percent from a month earlier, and 17 percent off the high in July 2008 of $71.92, CBRE data showed.

Some landlords, such as boutique investment company Heritage Realty Services, have slashed prices to attract tenants, said company president and CEO George Constantin. He cut rents at his Plaza District building, which is just 20 percent leased, from about $90 to about $65. He said he hopes to make back the difference by stepping up the rents in three years in a 10-year lease, instead of waiting until the fifth year.

“The first three years of the rent are very aggressive in the hopes to get us through the next three years,” he said. “We sweetened the deal in the beginning,” holding rent at about $65 per square foot, then bumping it up to approximately $75 per square foot in year four.

There was a positive trend in the market in February. The CBRE data showed a decrease in the net amount of space made available for leasing, or net absorption. It declined from a negative 4.19 million square feet in January to a negative 700,000 square feet in February.

Midtown

Midtown showed the weakest results among the three Manhattan markets. Leasing velocity pulled back in February from the month earlier. Just 560,000 square feet was leased, down about 17 percent from the month earlier and almost half the 1.02 million square feet leased in February 2008. The availability rate climbed 0.3 points to 13.2, percent and average asking rents fell by $5.99 to $68.77 per square foot in February, off 21 percent from the high of $86.57 in mid-2008.

Midtown South

Midtown South’s leasing market improved in February from the near standstill in leases signed the month earlier, but prices continued to fall. About 120,000 square feet of office space was leased, far more than in January when just 50,000 square feet was signed, yet just 38 percent of the market’s five-year monthly average of 320,000 square feet, the CBRE report said.

Average asking rents were down to $49.18 per square foot in February, another $2.62 cut off the average asking rent the month earlier.

The availability rate rose to 13 percent in February from 12.7 percent in January.

Manhattan’s lowest availability rate in any submarket was in Union Square, which was measured at 7.2 percent in its 3.99 million square feet of space, CBRE said.

Downtown

The Downtown market performed the best of the three markets in February, registering an increase in leasing and a decline in availability, although asking rents continued to fall. There was 230,000 square feet leased in February, 40,000 square feet better than the month earlier.

The availability rate fell to 10.1 percent from 10.4 percent in January, while average asking rents fell 2.5 percent in February to $43.64 per square foot, CBRE data showed.

The CBRE survey includes modern office buildings 150,000 square feet or larger in Midtown and 75,000 square feet or larger in Midtown South and Downtown, and excludes buildings owned and occupied by government agencies.

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