The Real Angle: Operating Costs Dent Landlords' Margins | The squeeze is on, and lower rents don't mean it costs less to run a building
You may be surprised to know that there isn't any sublease space available in MetroWest along the Interstate 495 corridor.
Well, that's only a slight exaggeration. There is very little available during a market cycle when you would expect otherwise. At the bottom of the last commercial real estate cycle in 2002 there was 8.2 million square feet of suburban sublease space available and today there is just 3.8 million square feet available.
Operating Margin
Many tenants who are out looking for space expect to find bargains resulting from shrinking businesses eager to unload their space, and these bargain hunters are always surprised by the sublease statistics. Also, many of the subleases are available from companies in very poor health, presenting a new layer of risk for the subtenant.
In the early 2000s many companies had excess space built up during the late 1990s boom. These companies were "banking" space for the future and when the music stopped they were saddled with it. In more recent years, tenants were cautious about banking space so there hasn't been much space to shed.
While it's true that building operating costs are passed through to tenants as they increase over a lease term, the landlord still has to include a base operating expense amount in the initial rent, and these costs have been increasing steadily. When the landlord's costs to run a building are factored in, rents are at all time lows along Interstate 495.
But the operating expenses baked into those base rents are increasing, and putting a squeeze on landlord's profits. Real estate taxes have nearly doubled in some cities and towns over the last 10 years, and today's high vacancy rates will not allow landlords to raise rates. Instead, they are doing everything they can to maintain margins. For example, tax abatement filings are up. Landlords are justifiably contesting tax assessments - and often winning - because appraised values have decreased.
Limbo
With rents at historic lows in so many properties, it would seem easy to pick an attractive space and make a deal, but some buildings can be dangerous for tenants.
A few buildings are failing, and entering a limbo phase before they are foreclosed or taken over by the mortgage holder or special servicer.
In this phase it is unclear whether the owner, or ultimately the lender, will be able to keep the promises they make to prospective tenants in a proposal.
The number of buildings in this predicament is small but increasing. It was expected that there would have been more foreclosed properties in 2008 and 2009, but many properties were able to extend loan terms and hope for a better day.
Since the market generally hasn't improved we are seeing those foreclosures more now.
For once, landlords and tenants have something they can agree on: The length of lease term. Both sides now want a long- term lease.
Many tenants recognize the advantages of locking in low rents for an extended period and are taking the opportunity. Landlords still prefer the longer term so they can more easily finance the property, pay for tenant improvements, and amortize tenant improvements over a longer period.
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