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Timing the Orange County Real Estate Market – 6 Reasons to Buy an Office Building for Your Business

Tuesday, May 4th, 2010

Timing the Orange County Real Estate Market – 6 Reasons to Buy an Office Building for Your Business

“Why didn’t I see that coming?’ This is what many business owners say to themselves when an opportunity has past them by. In a turbulent economy, when the future is unknown, there are always missed opportunities, causing company executives to postpone long term decisions, and it’s not until they look in the rear-view mirror that they realize they should have pulled the trigger. Each market cycle has its own unique aspects, but the result is generally the same – time is the main variable. With that being said, there are compelling reasons to believe that the timing is right for business owners to purchase a new building in Orange County.

If a company’s earnings are stable and its business plan has put it in a position to occupy the same size property for the next five years or more, purchasing a building could be the smartest business decision of 2010. As a result of the pricing in the market, the “lease versus own” scenario is coming back into alignment and buying a building is a smart investment choice once again.

For those businesses that fit these criteria, here are six reasons why now is the time to do so:

Reason #1: Prices have already declined in most markets by approximately 25 percent to 40 percent and buildings can now be purchased well below replacement cost.

The current sales taking place in the market are closing escrow 25 to 40 percent off peak values. In most cases, prices are back to their 2004 levels. Properties that have not sold linger due to sellers not being realistically priced in today’s market, but many of them are taking a harder look at their properties with an eye toward price reductions.

Replacement cost is a key component in real estate decisions and is a main factor for the most sophisticated real estate buyers. Buildings can currently be purchased well below replacement cost, allowing businesses to make the smartest investment possible.

Reason #2: There is excellent SBA financing available.

The SBA loan program has not been affected by the financial crisis, and the government is offering discounted fees. Businesses interested in purchasing a property can fix their occupancy costs for five to ten years at a record low interest rate (below six-percent). Not only is SBA financing inexpensive and easy to qualify for, but these loans only require 10 percent down.

If a business has the down payment for the property, it should qualify for this government-backed loan because there is an abundance of available capital and banks are interested in funding these comparatively low risk loans. These loans are preferred by banks because their portion of the loan is only 50-percent loan-to-value and is senior to a 40-percent government bond, making the bank’s risk relatively low. Many small businesses believe there is no money available for loans due to the current financial crisis, but banks continue to offer SBA loans to solid companies wanting to fix their occupancy costs. Also, for a short period of time, the government is significantly discounting the fees.

Furthermore, with inflation and interest hikes expected within as little as 12 to 18 months, the window of opportunity to secure favorable loan terms is now limited. Just one percentage point increase in the interest rate on a loan will have a significant impact on the total purchase cost, potentially amounting to tens of dollars per square foot. So don’t just focus on price. Look at the bigger picture!

Reason #3: The “lease versus own” scenario is back in line.

By buying a building, businesses can fix their occupancy costs for up to 10 years. As their own landlord, businesses will not have to speculate about future lease rates, when leases come up for renewal and owners raise rates to current market values. As the market has shown previously, lease rates will rise and landlords will have their day again.

Reason # 4: Orange County still has great fundamentals.

Orange County commercial real estate fundamentals for the long term are still very good and appreciation will return for owners who purchase space below replacement cost. As history has proven, as the economy recovers and rental rates increase back to record rates in the future, businesses that purchase their own building with fixed rate financing will benefit.

Reason #5: With a large inventory of buildings to choose from, businesses can find the right property and location.

With vacancy rates up and demand for space down, there are more buildings for sale to choose from. Buyers have the opportunity to locate properties with the exact features their businesses need and pay a lower price for them. In a market where sellers had the advantage, businesses were being forced to pay a higher price and compromise on quality. Today, buyers can get a superior price point on a building that better fits their needs.

The current market also allows businesses to negotiate the terms of the sale without the pressure of multiple offers. When the market was booming, properties were in escrow within 30 days, which did not allow sufficient time for negotiation. With today’s high inventory, buyers can now find the right building for their business needs at very favorable terms.

However, we expect to see stabilization in the owner/user office sales market in 2010 and are already see signs of less owner/user office buildings coming up for sale and a steady increase in buyer activity. As the inventory diminishes, so will the opportunity for businesses to buy a building that fits its exact needs.

Reason #6: Commercial real estate cycles typically follow residential and the residential market appears to have bottomed out in some sectors.

The residential market in Orange County appears to be showing signs of improvement, after establishing the bottom with prices that were approximately 40 percent lower than peak values in some submarkets. In these submarkets, residential prices have recently stabilized and are starting to creep higher.

3 important recommendations:

1. Allow plenty of time! The site selection, buying and loan qualifying process can take a long time. When contemplating such a long term commitment and substantial expenditure, don’t risk having to make short term decisions. We typically recommend clients to allow at least 12 months to complete the process to ensure the best results.

2. Hire an expert. If you are not intimately in tune with the latest market data, sale listings, off-market sale opportunities and sale comps and are not experienced in buying commercial real estate, hire a real estate broker to represent you. On most office listings the commissions are paid in full to the listing broker if you are not represented and the listing agreement prevents all or part of the fee from being renegotiated back into a purchase price discount. The benefits you receive from your own real estate broker representative will likely result in a reduction in cost several times the full commission paid if you’re broker is an expert in your marketplace/product type.

3. Don’t wait for the market to hit bottom. If you do, you’re too late. Most substantive data on market and submarket trends isn’t qualified and recognized as a definitive trend until 1-2 quarters after the fact. Learn the market and be proactive in order to time the market perfectly. We are already very close to the bottom!

4. Consider your options. Most of our clients want to buy. Most of them can’t. Most of them don’t realize this until they’ve spent months exploring buying opportunities. Don’t overlook leasing as an alternative. It requires significantly less up front capital expenditure and provides the operational flexibility for your business that a small building can’t afford. Today’s office leasing market offers plenty of opportunities for tenants to fix their occupancy costs at record lows for 5 years without having to buy.

For professional advice, market intelligence, a lease vs. buy analysis, financing options and scenarios and sale listings and off-market opportunities, contact Stefan Rogers at 949.263 5362 / srogers@voitco.com.

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San Diego Office Market on the Mend as Demand Is Up Year-Over-Year

Sunday, May 2nd, 2010

Uptick in Leased Space Reverses Recent Trends, Expectations Remain Muted

Stubbornly high unemployment rates will keep expectations muted for San Diego’s office market in 2010. Experts say a still repressed demand for space means a continued market in favor of tenants, perhaps through mid-2011, as vacancies trend up and landlords offer competitive rent discounts and other perks to fill those spaces.

Newly released, first-quarter reports by several prominent commercial brokerage firms indicate the San Diego County office market is generally better off than a year ago, but it could be another year or more before the current climate changes significantly.

While researchers anticipate job gains in the county’s market later this year, unemployment remains a pesky problem. According to the California Employment Development Department, the region’s jobless rate in March was 11 percent — up from a revised 10.7 percent in February, and 2 percentage points higher than March 2009.

“Employment trends have always been a big driver of office vacancy trends,” said Jon Boland, a vice president in the San Diego office of Voit Real Estate Services.

Voit’s first-quarter report on the local market puts the direct and sublease office vacancy rate at 16.34 percent, which is up from 15.89 percent a year ago, and nearly equal to the 16.37 percent during the prior quarter.

With rising vacancies come dropping rents. Boland notes that in a few instances, prime Class A office space in submarkets such as University Towne Center, which may have rented for $3.50 per square foot in a better economy, can be found at $2.20 a square foot.

“It’s giving tenants an opportunity to step up into some very good, newer Class A buildings, and that’s going to be to the detriment of the Class B and older Class A buildings,” said Boland.

Uptick in Sales and Leasing Activity

According to Voit, the San Diego region’s average asking lease rate per square foot (full-service gross) was $2.25 at the end of the first quarter, down 12.45 percent from last year’s $2.57 and 12 cents lower than the prior quarter. The latest average asking rent is well down from $2.76 per square foot, seen in the first and second quarters of 2008.

Experts say there was a notable uptick in overall office property sales and leasing activity in the first quarter compared with a year ago. Voit reports that new office construction has slowed substantially — with 346,636 square feet under construction at the end of the first quarter, about half the level of the prior period. The new leasing helped the region register positive net absorption of local inventory.

Boland notes that the absorption that did occur during the first period, a net of just over 200,000 square feet, got the year off to a good start but barely affected the region’s overall vacancy rate, since companies that moved into new spaces left older ones vacant.

Among the larger leases finalized during the first quarter were Nokia’s lease of 196,734 square feet in Rancho Bernardo, and Mitchell International Inc.’s lease of 141,214 square feet at Governor Park.

Less publicized than the big deals is a trend of corporate tenants “right-sizing” their office arrangements, says Bill Fleck, a senior managing director who does primarily tenant representation for brokerage firm Jones Lang LaSalle in San Diego.

Tenant Due Diligence

For instance, companies currently leasing more space than they are actually using, and who have no plans to use that excess square footage in the near future, are renegotiating their leases so they are responsible for less space at a lower cost. Landlords looking to retain tenants are often willing to open those renegotiations two years or more before the current lease is set to expire.

“A lot of times the landlord would rather negotiate to have that tenant stay in a smaller space, rather than see that tenant just go elsewhere, even if it means the landlord has to take back some of that space,” Fleck said.

Because of continued uncertainty in commercial real estate financing, and industry expectations that many commercial building owners could fall behind on payments to their lenders later this year, Fleck says tenants are compelled to do more due diligence as to the financial health of their prospective landlords.

“The building owner’s lender may have said, ‘We’re not investing any more capital,’ so the money may not be there to support capital improvements and other things that the landlord has promised to the new tenant,” he said.

Despite those lingering issues, the research and brokerage firm Marcus & Millichap ranks San Diego at No. 11 among 44 major metro areas in its latest annual report gauging the economic health of the nation’s office markets. San Diego this year moved up six spots from its No. 17 ranking in 2009.

The report tracks trends for potential office building investors, and ranks metro areas based on forward-looking indicators of supply and demand, including job growth, vacancy and construction rates…Click HERE to view the full artice.
Source: www.sdbj.com

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A Tenant’s Guide to Leasing Commercial Property by BuildingSearch.com

Thursday, April 29th, 2010

It seems that the new space decision affects almost all aspects of operations and yet most companies have very few managers with experience in coordinating a company relocation and negotiating a facilities lease.

Nonetheless, every few years companies must either relocate or extend their existing lease and face landlords with far more experience with commercial real estate.

A Tenant’s Guide to Leasing Commercial Property is designed to help level the playing the field for tenants by calling out common pitfalls to avoid, and processes to pursue that can help tenants make commercial property leasing decisions with confidence. The commercial property lease is typically one of the larger corporate expenses and one of the more important, visible decisions a management team or business owner can make. The most common mistake companies make during this time is attempting to avoid disruption to the business by not involving enough company stakeholders and department heads early on in the real estate site selection process. This tends to backfire causing the company to have to scramble to build internal consensus for what to do next as deadlines approach. Failing to define operational space requirements early on can lead to suboptimal results, unnecessary disruption, and unmet expectations.

Over the last 15 years of being involved in what must be 1,000 lease negotiations, relocations, and renewals of existing leases for tenants, I have seen many train wrecks and many successful real estate projects that were completed on time and on budget.

To minimize disruption and to get started on the right foot, here’s a sequential process and program that has worked time and time again for most companies facing a relocation or lease renewal:

1. Think holistically about real estate and how it impacts your business. Many companies have a business plan and ideally your company’s real estate commitments should be aligned to it as closely as possible. Real estate commitments are typically long in duration and therefore business leaders must try and anticipate the future needs of the business. The most common pitfall business leaders make is either not taking enough space to create a little wiggle room for the business, or take far too much space for growth initiatives that never panned out. Many leaders use a company move to refresh the business, reset expectations, improve moral, recruit new employees, and put the company in the best possible position to succeed. If you are managing a startup, your task is even more difficult as extreme flexibility is paramount as you may have no idea how your business will unfold and the space you will need.

2. Define your exact space requirements early. Using a few sample available properties that meet most of your operational requirements (if possible), have your furniture dealer and other equipment vendors help you layout the space to your specifications. Many vendors will provide this service for free in hopes of obtaining your business later on. This will help to flush out the size of the space required now and into the future as you plan for headcount and other potential changes.

3. Obtain solid broker representation. Commercial real estate is immediately complicated with many moving parts. Retain yourself a good broker to work with as early on as possible to help navigate and position your requirement in the marketplace. You are not obligated to a pay a fee (the broker’s fee is paid by the landlord) and you are not going to get a better deal on your own much less find the best building to house your company. There are numerous reasons why a tenant should use a broker representative, and no reason not to. The landlord has a vested interest in obtaining the highest rental rate and best deal possible regardless if you have a broker or not, and without using a broker tenants are forced into working with the landlord or the landlord’s agent to coordinate the lease by default. These people have far more experience negotiating lease transactions than most tenants and since you are going to get brokered one way or another, you might as well have your own advocate. Plus, brokers track all the spaces available in a market and can cut out a lot of unnecessary cycles for business owners and executives. They can also help you avoid unscrupulous people and buildings with known issues.

4. Put together a preliminary moving schedule. Don’t wait until the last minute to start looking for space as it always takes longer than you think to negotiate a lease and to equip a new facility for operations. You don’t want to be rushed through the process and forced into making hasty decisions because of some pending deadline like the end of an existing lease with costly “holdover” provisions. Create a move timeline or schedule with your broker to work against. Start the timeline with defining the space requirements, coordinating initial tours, term sheet negotiations, due-diligence, legal review, interior design, building permits, procurement of equipment and services, construction periods, and the furniture assembly and fit-out. Generally, the larger the space needed and the more tenant improvements involved, the earlier you need to start looking. As a rule of thumb if there is heavy construction involved than plan on looking about 12 months in advance. If the space requirement is small and no construction is involved, start looking for space 90 days in advance of when you need it. If some construction is potentially involved, start looking at least 6 months in advance.

5. Obtain preliminary approvals to proceed. Work with your broker to tour recommended properties and short list the best options. Run a detailed financial analysis for each building based on assumptions validated by your broker, building contactor, furniture dealer, and others required in moving, equipping, and operating each building. If necessary, meet with your management team to obtain their feedback and commitment to proceed based on the various scenarios presented. This will quickly weed out the type of spaces and buildings you should go after and why. This is also a good time to refer to earlier space surveys conducted early on and to your established moving schedule and timeline.

6. Start the RFP process. Instruct your broker to prepare a request for proposal (“RFP”) for eachbuilding owner on your short list. So that you are taken seriously in the marketplace, only choosebuildings that you would realistically move into if adequately motivated to do so by the landlord. YourRFP should include the following basic business points among other things:

- The length of lease you will entertain
- How the space is to be delivered by the landlord at the landlord’s sole cost and expense
- Proposed occupancy date
- Leasing concessions such as free rent, a tenant improvement allowance, moving cost allowance, furniture allowance, early lease termination provisions, etc.
- A “drop dead” date for the landlord’s response

Note that not all tenants need to go through the RFP process. If you requirement is small, the choices few, and the dollars involved not that substantial, many tenants and landlords prefer to move immediately into term sheet negotiations. Your broker will have a feel for how to do and hopefully put your company into a position where it is negotiating on a few properties in parallel to get the best deal.

7. Start lease negotiations. With hopefully attractive lease proposals in hand from one or more landlords on your short list, work with your broker to put together non-binding counterproposals (term sheets)based on market conditions and RFP responses received. Rely on your broker for guidance on what levers to push, and how to be aggressive with each landlord without being ridiculous. Consider needed flexibility such as early lease termination provisions, expansion options, and automatic renewal options to incorporate those into your proposals. If there is a considerable amount of construction involved and other leasehold improvements, it would be a good idea to develop your own tenant improvement budget to help guide negotiations.

After reviewing responses back from the various landlords to your counterproposals, it is time to get your senior management together and review proposals to determine the finalists based on you and your broker’s recommendations. Update earlier financial models and be prepared to address a series of questions regarding anticipated costs, risks, rewards, and why these buildings are better than any of the others you looked at or received proposals on. Prepare your final and best non-binding counterproposal(s) asking each landlord to include a draft lease with its response. If you like one building more than any of the others (this happens most of the time) you should consider asking the landlord to take the building off the market as you negotiate a lease in good faith. Obviously at this point you only want to be negotiating on buildings that you can realistically move into on time and on budget. The counterproposal stage may go a few rounds and include verbal negotiations. Work with your broker to ensure that you have an executed non-binding term sheet that the parties can rely on to review the lease against.

8. Obtain legal assistance. Using the final term sheet, engage your attorney to help with the review and negotiations of the lease document. Use your broker and attorney to determine what is “market” and what to push for. Depending on the size of the lease commitment and dollars involved, you may wish to cap your attorney’s hours and involvement. Gather your broker’s concerns with the lease and determine how best to communicate your concerns to the landlord. Usually a conference call with all parties involved is best after initial lease comments have been distributed. Where should you focus your energy? The following lease terms are important and should certainly be reviewed and understood clearly:
- The base rent and rental escalations if any
- All expenses associated with operating the building and who pays for what expenses
- Who handles building repairs and how those expenses are paid for
- Te treatment of future capital improvements
- The payment of real estate taxes and insurance expenses
- The tenant work letter and how the building and space will be delivered to the tenant
- Building use provisions including rules and regulations
- Sublease/assignment rights
- Tenant audit rights with respect to building expenses passed through to the tenant
- Determining fair market rent for options to extend the lease term

In many cases tenants will elect not to use attorneys for small leases. If so, pay attention to the above clauses and make sure you are dealing with a highly reputable landlord.

9. Complete your due-diligence. As you work through the lease document, it is time to carefully review the condition of the building you may end up living in. How much due-diligence to apply is often dictated by the total size of the financial commitment involved, the lease structure (triple net or NNN, gross lease, or full service lease), the age of the building, and the warranties available. For example, if the lease structure is triple net (NNN), which forces the tenant to be responsible for the electrical and mechanical systems servicing the building and the roof membrane, it is important to inspect the building similarly to how home owners conduct inspections of the homes they purchase. If you are the single tenant or about to take on a lot of space, you may wish to have the roof inspected or see if has recently been inspected and what the outcome was. Determine if the roof leaks, the useful life remaining on the building systems, and if the building has been well serviced or if there is deferred maintenance. If the building is occupied you can certainly talk to the tenants and see what they have come to find. If you are planning structural changes to the building and other improvements that will involve permitting, be aware that these will trigger an audit of the building by the city municipality to determine if the building has all the necessary life/safety equipment and is in compliance with other building codes. Make sure to understand what will be required to obtain approved occupancy status, and who is going to pay for what if code compliance issues are triggered by planned work to the building.

10. Work in parallel with vendors to move into the building on time. Ideally you want to shut down on a Friday at your current location and open on a Monday in the new location. To do this you will have to plan ahead to avoid painful disruptions and delays. While negotiating the lease document and completing your due-diligence, you will likely need to set into a motion a series of events so that you can move into the building on time. This might include provisioning telecommunications and data circuits, selecting contractors, receiving bids for work and equipment, generating quotes from furniture dealers, and arranging for the provisioning of various services. Put yourself in a position to pull the trigger on multiple decisions in parallel working down to granular details such as ordering business cards, changing your mailing address, updating your website, and sending out “we have moved” announcements to your customers and their billing departments.

Finding and securing the perfect building for all the right reasons is obviously the goal here, but sometimes that’s not always possible and in fact most of the time, it is not. Concessions are often required and expectations reset after finding out that what you want in a perfect world, just isn’t possible. Make these adjustments early and your site selection process will go much smoother as a result.

Clearly this guide doesn’t pertain to everybody and for the smaller leases very little of it is applicable as the dollars involved just isn’t worth the drama of a lengthy lease negotiation. I hope this guide serves you well and we appreciate your use of BuildingSearch.com. Click HERE to view the full article.
Source: Jon Condrey / www.buildingsearch.com

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Q1 Orange County Office Market Garners Mixed Reviews

Tuesday, April 20th, 2010

ORANGE COUNTY-The county’s office market showed some signs of stabilization during the first quarter, but it still posted significant negative net absorption and overall remains weak.

Those are some of the conclusions in reports on first-quarter activity in the county from Voit Commercial Real Estate Services, Delta Associates and Colliers International.

“We are beginning to see signs of overall stabilization and improvement,” in the county’s office market, says Jerry Holdner, vice president of market research for Voit. Holdner tells GlobeSt.com that the most promising trend is that the overall total of direct and sublease space available in the county remained at 23.75% in the first quarter, the same as in the fourth quarter.

Much of that 23.75% is the same space this quarter as last―it was sublease space and has now gone back to landlords as direct space. Holdner says that he’s hopeful that the flattening in the amount of available space on the market is a sign that the market has bottomed out, although that remains to be seen.

Holdner also points to an increase of 200,000 square feet in the total of office building sales for the first quarter when compared with the first quarter of 2009. The figure is not earth-shattering, he says, but it means that 2010 is off to a better start than last year.

Despite the stabilizing signs, the county’s office market still posted negative net absorption of 414,162 square feet in the first quarter, according to the Voit report, which tracks about 108 million square feet. Delta Associates, which produces its report in association with Transwestern and tracks nearly 120 million square feet, pegs the negative net absorption at 936,000 in the first quarter. Colliers reports more than one million square feet of negative net absorption in the quarter but still pegs the overall availability at a figure close to Voit’s, 23.2%.

Colliers sees a positive note in that leasing activity “slightly increased from the previous quarter,” but the company’s report views the Orange County office market as “quite far off from a recovery.” It says that tenants “continue to consolidate their operations while the creation of new companies is nearly non-existent,” meaning that office users continue to give back space to landlords.

One point on which the market-watchers are unanimous is that job growth is essential for the market to recover. “It’s all about jobs,” says Holder. He says the consensus among economists seems to be that the county will post job growth by the end of this year, a view that contrasts with the thinking a year ago, when “At that time, most people didn’t have any sense of when job growth would occur,” he says.

Office rental rates, which reached record highs in Orange County before the recession pushed them downward, continued to slide in the first quarter. The average asking full service gross lease rate per month per foot in Orange County was $2.12 in the first quarter, a 10.55% decrease over last year’s rate of $2.37 and five cents lower than last quarter’s rate, according to the Voit report. It notes that the record high rate of $2.77 was established in the fourth quarter of 2008 and that class A rates for the county are averaging $2.29 FSG, with the highest rents in the Airport market, where they are averaging $2.41 FSG.

New construction has tapered to the point that it is much less of a factor in adding new space, according to the Voit report, which shows first quarter total space under construction at 305.500 square feet, most of which was medical office space. “The slowdown in construction has and will ease the upward pressure on vacancy and the downward pressure on lease rates,” Holdner’s report says.

Although the office investment sales activity slowed from the flurry of last year, Colliers points out that “Class A high rise office buildings located in Orange County continue to attract interest from potential buyers,” citing the sale of Griffin Towers in Santa Ana. In that deal, Los Angeles-based Maguire properties sold the office towers to a venture of Angelo, Gordon & Co. and Lincoln Property Co. for $90 million, less than half the $200 million for which Maguire refinanced the towers in 2008.
Source: www.globest.com

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Inflection Point: Renewed Hiring, Leasing Start to Lift Nation’s Office Markets

Thursday, April 15th, 2010

Vacancy Rates Have Plateaued and Lease Transactions Are Picking Up, but Declining Rents and Operating Income Continue to Challenge Office Landlords

More companies that occupy office space began hiring again during the first quarter and tenants are beginning to renew leases and make other occupancy decisions postponed during the past two-and-a-half years of economic dislocation. The increase in transaction activity resulted in plateauing office vacancy rates across many U.S. office markets during the past quarter.

However, the increase in leasing activity is still well below peak levels and the vacant space in buildings is expected to fill gradually, with net absorption remaining fairly flat in coming quarters. Office rents are expected to finally begin rising in most U.S. markets by the middle of next year, but many landlords won’t see significant growth in property net operating income for several years.

Still, first-quarter numbers compiled by CoStar Group show promising signs amid the lingering pain for the commercial real estate industry, including projections of more than 100 million square feet of leasing during the first three months, which would rank as one of the strongest leasing quarters of the last several years.

“We appear to be at an inflection point,” Andrew C. Florance, founder and CEO of CoStar Group Inc., said recently during the company’s First Quarter 2010 Office Review and Outlook webinar. “We’re seeing a lot of signs of recovery.”

Economy.com and U.S. Bureau of Labor Statistics data suggests that the U.S. will see significant employment gains over the next three years, including jobs in the office sector, added Dr. Norm Miller, vice president of analytics for CoStar, who presented the overview of market conditions, along with Florance and Jay Spivey, senior director of analytics.

“Professional business service jobs continue, over the last two quarters, to be positive. When you net out the financial jobs that were lost and the information services jobs that were lost, we still have a net positive of 78,000 [office] jobs,” Miller said.

Miller cited forecasts that the nation would add a net total of 230,000 office jobs this year, resulting in the take-up of an additional 46 million square feet of space.

Miller acknowledged that there’s a lot of slack in the market and not all of the space taken would translate right away to positive absorption. But it will start to chip away at the shadow space plaguing office landlords and tenants, empty space in buildings that companies haven’t yet put back onto the market for direct or sub-lease.

“If the economy continues to move in the direction it’s moving, we’re coming out of the woods here on the leasing marketplace, and it’s fairly good news,” Florance said. “Any new absorption we see will cause vacancies to go down.”

First-quarter 2009 was the worst three-month period for leasing in a decade as tenants, realizing that demand was shrinking and rents were headed downward, delayed decisions to sign or renew leases.

However, “we have now seen four solid, sequential quarters of increase in total leasing activity in the United States,” Florance said. “People are out there taking advantage of what they think are good deals, or they’ve delayed as long as they can.”

By the time all the leases are tabulated and accounted for, “given what we’re seeing currently for leasing activity in the quarter, we’re anticipating and are confident that we’re going to see one of the best quarters for leasing activity that we’ve seen in five years,” he added.

Underscoring the boost in leasing activity is 20% year-over-year growth in CoStar Group, Inc.’s office, industrial and retail property listings in 2009 from the previous year, a jump Florance described as “remarkable.” The Washington, D.C.-based company added 750,000 office, industrial and retail listings and removed 500,000 listings — the majority of whom signed leases — for a net increase of nearly 250,000 listings in 2009.

The stepped-up leasing activity and improving office employment numbers have yet to translate to overall gains in net absorption of office space. About half of the top 20 markets tracked by CoStar posted positive absorption while half continued to show a net loss of occupied space in the first quarter. Houston, continuing to benefit from the surging energy market, led all gainers with positive absorption of 1.4 million square feet, followed by the San Francisco Bay Area with 1.3 million square feet, South Florida at 800,000 square feet, Denver (700,000 sf), Phoenix (600,000) and Minneapolis (500,000). Northern New Jersey, Washington, D.C., Long Island and Boston also showed modest positive absorption.

Markets showing the highest negative absorption include New York City (-2.1 million square feet); Los Angeles (-1.3 million); Westchester/South Connecticut (-800,000); Chicago (-700,000) and Orange County, CA (-500,000)

While an improvement from 2009, when three out of four quarters showed negative absorption, CoStar is expecting flat absorption for the next few quarters as companies gradually work their empty space out of the system.

CoStar and its research and analytics subsidiary, Property and Portfolio Research, Inc. (PPR) are forecasting that the national office vacancy rate has peaked and will begin to fall to what is considered a healthy 10% by end of 2013 and into 2014. While 30-basis-point vacancy increases have been the norm in recent quarters, they’ve slowed to 10 bps, with the national office vacancy rate ending the first quarter at 13.54%. Availability, space offered but not yet actually vacant, is significantly higher at 17.7% and rising slightly faster, but it’s leveling off as well.

New York City had the lowest vacancy rate among major markets at 7.9% — high compared to the 2% vacancies a few years ago at the height of the era of hot financial services markets, which prompted rent spikes in Manhattan — but in line with the 20-year NYC average.

Houston had a significant 0.5% decrease in vacancy and San Francisco Bay Area fell 0.4% in the first quarter vs. the fourth quarter, while demand for office space in Atlanta and Phoenix continued to erode, adding 0.6% and 0.4% to their vacancies rates. Phoenix’s rate was the highest in the nation at 21.4%, followed by Detroit (18.7%), the fast-delivering Dallas-Fort Worth market (17.9%), Atlanta (17.4%) and Orange County (16.2%).

Rents will continue to pose a challenge for office landlords in coming quarters. Nominal rents adjusted for inflation have fallen every quarter since early 2008 and are now down 20% from a decade ago, from over $24 per square foot to below $19, sharply cutting into property net operating income.

As office vacancy rates fall and occupancy levels climb, rents will gradually begin to rise in a couple of markets and will be flat in many others. While rents in a number of metros are still falling, CoStar forecasts that overall U.S. office rents will be in growth mode by the middle of next year.

However, growth in average net operating income won’t automatically follow. As leases signed in 2007 at record high lease rates come up for renewal, actual NOI will continue to contract until late 2014, with no significant growth in property income until 2015.

That said, if employment and economic growth matches up with analysts’ expectations, investors will begin anticipating that NOI growth within a year or two.

“If we see three or four quarters of significant employment [growth] in the finance, insurance, real estate space, you can begin to anticipate significant value growth. That’s an if,” Florance cautioned.

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Los Angeles Economic Index Hints Recovery, But Jobs Missing

Thursday, April 15th, 2010

LOS ANGELES-An index of the state’s economic activity could bode well for office buildings here and in the rest of the state, but jobs remain the missing ingredient. That’s one of the conclusions that can be drawn from the latest Comerica Bank California Economic Activity Index, a monthly analysis of the state’s economy by the Dallas-based bank.

The index for January, the latest month for which figures are available, remained at 102, below the peak that it reached in October for a third consecutive month, but it was still up 10 points, or 11.4%, from the March 2009 cyclical low. The January reading also was up four points from the average for all of 2009.

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Such numbers are not exactly cause for celebration, but they show an improving trend. Dana Johnson, chief economist at Comerica Bank, said in the bank's monthly news release regarding the index that, “Excluding employment, our index has shown broad-based improvement since last March.”

That is mixed news for the office market, which is counting on job growth―perhaps even more than other property sectors are counting on it―as a source of demand. Economists and others who study the office market are virtually unanimous in their view that job growth is a key to recovery in the office markets throughout the US.

Says Johnson, "Although our index has stalled this winter after sharp gains last summer, it still appears to me that the California economy is in the early stages of a moderate recovery. If, as I expect, employment gains emerge in the next few months, I will become much more confident that a sustained private-sector expansion is taking hold.”

In the previous month's statement regarding the index, Johnson pointed out that, as it has done consistently over the course of the last year-and-a-half, employment contributed negatively to the California index. However, Johnson also noted that, "Given encouraging growth trends emerging nationally and globally, however, California should still be set for a sustained expansion that begins creating jobs in 2010."

The California Economic Activity Index equally weights nine, seasonally adjusted indicators of real economic activity in the manufacturing, tourism, travel and trade sectors, as well as job growth and consumer outlays. The index is benchmarked so that 2008 equals 100.

In addition to the California Economic Activity Index published by Comerica, another recently issued report that holds implications for the L.A. area is the Transwestern Outlook a quarterly report by Transwestern and its research affiliate, Delta Associates. The Transwestern study says that the LlA. Basin economy “will likely remain relatively weak in 2010, although the outlook is improving.” Employment losses have begun to scale back and losses will continue to ease during the year, as activity in most sectors begins to turn around,” the report says.

According to Transwestern’s report, job losses in the Basin in 2009 totaled 443,400 on an average annual basis, and this year, job losses will likely moderate to a loss in the 150,000 range. “As economic growth picks up, we expect job growth in the L.A. Basin to reach close to 100,000 in 2011 and 120,000 in 2012,” the Transwesterrn-Delta analysis says. “Growth likely will be driven by a return to health in the Basin’s core industries, particularly in the professional services sector,” the report states. “However, if the housing and consumer sectors regress, as government stimulus winds down, the economic recovery could take longer to develop. ”

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Just Released – Voit Real Estate’s 1st Quarter 2010 Orange County Office Market Report

Friday, April 9th, 2010

Orange County Office and Industrial commercial real estate continues to stabilize

Voit Real Estate Services is has just released it’s latest 1st quarter 2010 Orange County commercial real estate market reports for the office and industrial real estate sector. Voit’s 2010 Commercial Real Estate Market forecasts and a complete list of reports for Office, Industrial, Flex, R&D and Retail commercial real estate for Orange County, San Diego County, Riverside County and Las Vegas will be available shortly at www.voitcts.com. Click HERE to view the reports.

Highlights for the Orange County Office Market are:

Vacancy – Up
Net Absorption – Down
Lease Rates – Down
Transactions – Down
Construction – Dow

While the above trend is similar to that witnessed in the 4th quarter 2009, it is clearly slowing and we are still expecting the market to rebound in late 2010. A typical early indication of this is the fact that asing lease rates are already rising on many of the more sought after Class B office buildings and activity and deal volume has increased dramatically over last quarter.

For more information or impartial advice on what Voit’s market data means for your business and how to take full advantage of the “Tenant’s Market” to reduce overhead and realign your real estate with your business plan, contact Stefan Rogers at 949.263.5362.

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Good Advice on How a Commercial Tenant Representation Broker will Save You Money

Wednesday, March 24th, 2010

Your primary business is running your company. How often do you lease office space? Hopefully, you don’t have to do so more than every 3 to 5 years or so; the same with lease renewals.

The bottom line is that you rent office space only a few times in your business life. Landlords on the other hand rent space over and over again. In most cases, they even hire a listing agent to help market the property and advise them. Do they have an unfair advantage? You bet they do. How do you balance this unfair advantage? Engage the services of your own qualified tenant representative.

Many tenants have a fear that by engaging the services of a tenant representative they will end up having to pay more in rent so that the landlord can pay the tenant representative. I am sure you have heard the sales pitch from an agent that engaging a tenant representative doesn’t cost you anything. The response I hear to this is “the landlord tacks on the fee on top of the lease rate.” So, who is right?

When it comes to negotiating for office space, there is no question that a good tenant rep will not only save you money, but will also make sure you don’t make any critical mistakes.

Not to mention, there is usually already a real estate fee built into the asking price. This is paid whether or not you have representation. Typically, what happens is that the fee, usually 4% to 6% of the gross lease amount, is split between the tenant representative (leasing agent) and the listing agent. There really is no additional fee tacked onto the lease rate and you won’t save anything by not having representation. The listing agent, who represents the Landlord – no matter what they tell you – will get the whole thing.

What about lease renewals? Should you also engage the services of a tenant rep? Absolutely! How a tenant representative gets paid on a renewal is negotiable. Should they be paid a full fee on a renewal negotiation? The answer depends on how much work is involved. If is just a matter of going out and doing a market survey then negotiating the deal, they probably don’t deserved a full fee. Most tenant reps will work as consultants either hourly or for a predetermined flat fee. On the other hand, if you want to consider other alternative locations, request proposals and do some preliminary negotiations on other properties, it is justified. It is a comparable amount of work that would have to be completed if you were moving. Or at least a half of a fee is justified, the leasing side of a commission.

How will a tenant rep save you money?

The leasing process is generally complex. After labor costs, your investment in office space may be your most expensive line item and decisions you make will have an impact on your company’s profitability. The tenant representative is your guide through the process.

Market knowledge is a key ingredient in which a qualified tenant representative can make a big difference. Having a grasp on asking rates versus deal rates and incentives available is important to make sure you get the best terms available.

A qualified tenant representative understands the numbers and is able translate data into implications for your business – advice on growth strategy within a particular building or market, for example. Tenant representatives are also able to perform financial analysis to help you select the most cost effective location.

Expert negotiation skills are critical for a favorable outcome. Representation gives you subtle leverage during negotiations, informing the landlord that you are professionally represented and undoubtedly advised of alternative sites and comparable lease rates. As an added benefit, a tenant representative may know the temperament of a particular landlord and/or landlord’s representative, and recognize how far to push the negotiations without jeopardizing the transaction. This is a definite advantage when it comes to lease renewals, too.

Familiarity with the documents is a must. Tenant representative have a working knowledge of the documents necessary to conduct the transaction. These documents include requests for proposal, letters of intent, lease agreements and workletters and vary from market to market. A tenant representative knows how to customize the documents to meet your needs.

A few important questions to ask and receive acceptable answers when you look for a tenant representative:

1. Are you free of any conflicts of interest if we work together?

2. Are you a primarily tenant advocate or a listing agent?

3. Do you have time to work on this project?

4. What other projects are you currently working?

5. What is your experience in finding properties like mine?

6. How many tenant representation transactions have you handled in the past 3 years?

7. What is your negotiating philosophy?

8. Are you knowledgeable about market conditions?

9. How do you handle conflicts of interest, such as when you show me space that you or your company represents on behalf of a landlord?

10. How would you describe your reputation in the business community?

11. Can you supply references?

12. Do you work with an Exclusive Representation agreement?

13. What happens if I’m not happy working with you?

14. How do you get paid? What commission you expect to receive?

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Orange County Office Leases Pick Up as Owners Get Aggressive on Rents

Tuesday, March 9th, 2010

Office Leases Pick Up as Owners Get Aggressive on Rents

San Francisco-based Shorenstein Pro-perties LLC completed the largest office acquisition in Orange County for 2008 when it paid nearly $211 million for Irvine’s Main Plaza complex near John Wayne Airport—more than twice the price paid for any other local office complex that year.

Now the owner of the twin 12-story, Main Street building—a national investor that’s shown no signs of being in financial distress—is making news again in OC, with one of the more hard-hitting leases seen for a high-end office in Irvine.

SullivanCurtisMonroe Insurance Ser-vices LLC recently moved its headquarters to Shorenstein’s 1920 Main St. building, leasing 25,237 square feet of space. The insurance brokerage, which relocated from an older building down the street, also got its name on top of the building.

The seven-year lease is for $4.4 million, which puts monthly rents at a bargain-basement price of about $2.08 per square foot.

The lease is one of the most aggressive transactions to take place in the airport area in the past 18 months, according to Jake Stickel, a broker with the Newport Beach office of CB Richard Ellis Group Inc.

For similar higher-end offices around John Wayne airport, monthly asking rents have been running about $2.50 per square foot. Near the peak of the market, those rents were more than $3 per square foot.

“The rental rate the tenant was able to lock in at this class A property is comparable to the rent they were paying under their previous lease in a class B building,” said Stickel, who represented the insurance com-pany along with CB Richard Ellis Group Inc.’ Carol Trapani and Tasha Monroe.

Trend

Expect to see more eye-opening leases as existing and new property owners in OC look to weather the ongoing slow office market, tenant brokers said.

Local owners with strong balance sheets, including Newport Beach’s Irvine Company—and presumably Shorenstein—would rather fill up their buildings now at below-market rates than continue seeing their buildings remain empty during what’s expected to be a slow recovery for the local market.

Meanwhile, owners that bought distressed properties in the last year at steep discounts are hoping to leverage their cash positions to make deals that other financially-strapped landlords can’t afford.

“It’s a tenants’ market, as everyone knows,” said John Tumminello, principal for Newport Beach-based investor Greenlaw Partners.

Late last year, the company partnered with San Francisco-based Westbrook Partners and Chicago’s Walton Street Capital LLC to buy Irvine’s 2050 Main St. office tower.
Source: www.ocbj.com

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Are you losing money? – 10 Common Pitfalls for Commercial Tenants to Avoid

Friday, March 5th, 2010

“Are You Losing Money?” 10 Common Pitfalls for Commercial Tenants to Avoid

Although reading a commercial lease can be difficult and time-consuming, the consequences of not reading can be infinitely more unpleasant. Tenants frequently will only look at the provisions that have direct economic impact. There are, however, provisions buried in the lease which may have unintended impact on the tenant. While a tenant’s ability to delete or modify these objectionable provisions will depend on a number of factors, including, among others, the size and reputation of the tenant, market conditions, the vacancy level of the building, the size of the space and the length of the lease term, every tenant should make an effort to ameliorate the effect of these pro-landlord terms. Some of these provisions are explored below.

1. Common Area Maintenance (“CAM”) Expenses (also known as “Operating Expenses”):

Landlords may try to use this provision as a “profit center.”

• An Operating Expense or CAM provision requires the tenant to pay its pro rata share of the operating expenses incurred by the landlord in the operation and maintenance of the building. Unfortunately, landlords have expanded the list of expenses to include every imaginable expenditure. By doing so, some landlords have turned this provision into a profit center. Instead, the provision should only pass through to the tenant legitimate expenses relating to the operation and maintenance of the common areas.

• The tenant should carefully review the history of the building’s CAM charges for at least the three prior years. This will enable the tenant to compare the amount of operating expenses and their annual increases to other comparable buildings to determine whether they are reasonable, and to estimate what the charges might be in future years.

• The CAM provision should be rewritten so that only “legitimate” CAM charges are included and items such as capital improvements and compliance with laws are excluded. Most landlords will accept what has become known in the industry as a standard list of operating expense exclusions.

• Particular attention must be given to the definition of the base year in any CAM clause which requires the tenant to pay its prorata share of expenses incurred over a base year. The tenant should make certain that the tenant has no obligation to pay for expenses during the base year and that the base year variable expenses are subject to a “gross up” to reflect the full amount of operating expenses that would have been incurred by the building had it been 100% occupied.

• Watch out for any provision making the landlord’s determination of CAM charges final. The tenant should reserve the right to audit the landlord’s expenses and to review the landlord’s calculations.

• Review the operating expenses clause against the compliance with laws, repair and maintenance and real property tax clauses to prevent the landlord from passing through to the tenant expenses which it may have solely assumed under these and other clauses.

• Alternatively, if the situation permits such negotiation, attempt to insert a maximum upper limit (“cap”) on CAM charges, or a “kick out” clause allowing the tenant to terminate the lease if CAM charges exceed a certain amount.

2. Repair and Maintenance Provision:

Landlords may try to use this provision to require the tenant to repair and maintain areas located outside the leased premises.

• There are great distinctions among the clauses that define the tenant’s obligations under the lease with respect to repair and maintenance.

• The tenant must pay particular attention to any repair and maintenance provision that requires the tenant to repair and maintain items or areas that are traditionally the landlord’s responsibility.

• A typical lease will define repair and maintenance obligations with reference to the interior of the premises. However, depending on the definition of the premises, this may result in the tenant’s having to repair and maintain such things as plumbing, sprinklers, HVAC ducts, and the building’s structural elements.

• It is imperative that the tenant limit its repair and maintenance to the interior surfaces of the leased premises, excluding any structural elements or building systems located therein.

• Define exactly the extent of the tenant’s repair and maintenance obligations, taking care to exclude items such as regular wear and tear or items that are covered by the landlord’s property insurance.

• If the landlord is to be held responsible for the repair and maintenance of certain items, the lease must be specific about these items so that there is no doubt as to which party has responsibility.

• Finally, the tenant should try to make certain that the costs of the repair and maintenance for which the landlord is responsible cannot be passed on to the tenant, through, for example, the operating expense provision.

3. Real Property Taxes:

An unsuspecting tenant may find itself paying real estate taxes and special assessments for a period beyond the expiration of the lease.
• The real property taxes provision defines the respective obligations of the landlord and tenant for real property taxes. Landlords have expanded the definition of real property taxes to include any type of tax assessed against the property, the landlord or for doing business and are increasingly defining taxes to include future taxes of any sort, including rent taxes or income taxes.

• Define precisely which taxes and/or assessments are to be included in the definition of real property taxes and be sure to exclude federal or state income, franchise or estate taxes.

• Make certain that the tenant’s tax and/or assessment responsibilities do not survive the tenancy. That is, if, for example, a three year installment for assessments becomes due at the commencement of the last year of the tenancy, the tenant should be responsible only for its pro rata share of the total amount (i.e. one year).

• The tenant should be aware that its tax liability may increase dramatically if the landlord sells the property, particularly if the landlord has held the property for a long time and property values have greatly increased. The tenant may wish to put some limitation on increases in real property taxes resulting from a change in ownership by, for example, having increases occur incrementally over time or completely eliminated.

4. Compliance with Laws:

A tenant not appreciating the potential effects of this provision may find itself footing the bill for earthquake retrofitting, asbestos abatement, sprinkler installation, or compliance with the Americans with Disabilities Act.

• This provision typically requires the tenant to perform potentially expensive replacements, alterations, or improvements of the leased premises to comply with existing or future laws and government orders relating to the leased premises.

• In some instances the landlord agrees to bear the burden of complying with these laws or the lease places the onus to comply with such laws directly on the tenant.

• In either case, it is the tenant who, depending on the particulars of the situation, may have to foot the very substantial bill for items such as asbestos abatement, retrofitting or compliance with the Americans with Disabilities Act.

• If the landlord is to bear the responsibility, the tenant must curtail the landlord’s ability to “pass on” the cost of compliance through other provisions, such as the operating expense provision.

• If the tenant is to be responsible for compliance with laws, the landlord should represent and warrant to the tenant in the lease that the building is in compliance with all presently-existing laws and limit its responsibility for compliance with future laws to those items necessitated solely due to the tenant’s particular use of the premises.

•The tenant should try to place a cap on its annual exposure under this provision.

5. Assignment and Subletting:

Asking the landlord for permission to assign or sublet the premises may give the landlord the ability to terminate the lease.

• In the typical commercial lease, the landlord requires the tenant to get the landlord’s consent prior to any assignment or sublet.

• Negotiate several exclusions from the consent requirements, including assignment or sublet for reorganization purposes and space-sharing arrangements up to a defined square footage (the latter has particular application to office leases or retail leases where the business is seasonal).

• Where the lease requires consent and the landlord consents to an assignment or sublet, the landlord may get to keep all rents paid by the assignee or subtenant in excess of the tenant’s fixed rent obligation to the landlord. The tenant should ask for at least a portion of this “excess” rent.

• Furthermore, it is imperative that the tenant have subtracted from the “excess” the book value of leasehold improvements made for the assignee or sublessee and any broker’s commissions paid by the tenant in locating the assignee or sublessee. Not doing so may severely overstate the excess rent and can result in a windfall to the landlord.

• In the absence of a release, the tenant will continue to bear the economic risks of paying the rent and all other charges under the lease for the balance of the lease term, including any existing options to to extend or renew (“Options”) following an assignment. The tenant should attempt to get a release of liability for the Option periods.

• Carefully review the lease to determine whether it contains a recapture clause. Under a recapture clause, a request by the tenant that the landlord consent to an assignment or sublet triggers an option enabling the landlord to terminate the tenant’s lease. The tenant should have the recapture clause deleted or should insert an option allowing the tenant to withdraw its request if the landlord elects to terminate the lease.

• Insert a clause that requires the landlord to give the tenant notice of any default following an assignment so that the tenant will have the right, but not the obligation, to cure the default and regain possession of the premises.

6. Subordination, Nondisturbance and Attornment (SNDA) Provision:

If the landlord asks you for what amounts to a favor for the benefit of its lender, the tenant should be sure to get something in return.
• This provision defines the important relationship between the landlord’s current and future lenders and ground lessors, and the tenant in the event the landlord defaults on its loan obligations or obligations to the ground lessor. A subordination clause typically readjusts the priorities that normally would result from general legal rules, by providing, for example, that any existing or subsequent lender of the landlord can elect to deem its deed of trust superior or junior to the lease, regardless of the date on which the lender’s deed of trust was recorded. An attornment provision generally obligates the tenant to recognize the foreclosing lender or ground lessor as the new landlord under the existing lease.

• In exchange for its subordination and attornment agreements, the tenant must assure continuation of its lease by requiring the landlord’s lender or the ground lessor to agree not to disturb the tenant’s lease if the lender forecloses or the ground lessor asserts its right to the property. This becomes especially important to a tenant in a market with little inventory and escalating rental rates. Without a nondisturbance clause tied to the subordination and attornment provisions, the tenant’s lease could be wiped out by virtue of the subordination provision.

7. Tenant Remedies (Termination and Abatement Rights):

A lease containing waivers of tenant remedies may leave a tenant with no place to turn if the landlord defaults in its obligations.

• This clause defines what, if any, remedies are available to the tenant in the event of a default on the part of the landlord.

• Many commercial leases cause the tenant, by accepting the terms of the lease, to waive a host of remedies provided by the law. Other leases fail to mention tenant remedies entirely.

• When negotiating a lease, ideally the tenant would like to preserve its “repair and deduct” rights so that if there is a problem, the tenant can remedy the problem and deduct the cost from its rent; in most cases the landlord will require a waiver of this right.

• A tenant should, therefore, negotiate a lease which contains abatement and termination rights.

• Abatement rights allow the tenant to abate, in proportion to the area of the premises affected, the amount of rent it pays if the landlord fails to remedy items for which it is responsible that interfere with the tenant’s use of or access to the leased premises.

• Termination rights may give the tenant the option, under the above circumstances, to vacate the entire premises without further obligation.

8. Termination, Relocation or Expansion Rights:

A tenant who has not had its lease carefully read may be surprised to learn that the landlord has reserved the right to unilaterally terminate the lease or relocate the tenant.

• A termination provision in favor of the landlord allows the landlord to unilaterally terminate the lease, usually on the occurrence of some condition.

• A re-location provision allows the landlord to relocate the tenant to other premises within the building.

• An expansion provision, on the other hand, may give another tenant the right to expand into the tenant’s premises and may allow the landlord to terminate the tenant’s lease or relocate the tenant.

• Ideally, a tenant should not agree to such clauses.

• If conditions require acceptance, the tenant should make certain that it can only be relocated to a comparable location and position and that the landlord has to pay for all expenses related to the relocation, including the cost of moving the business and installing tenant improvements.

9. Damage and Destruction:

A trap for the unwary.

• This provision provides what will happen if the leased premises or the building housing the leased premises is damaged or destroyed. It typically provides that the landlord may elect, in its sole discretion, to continue the lease or to terminate it. In the case of continuation, it usually provides for an abatement of rent in the same proportion that tenant’s use of the leased premises is impaired.

• The tenant must make sure that the abatement of rent language is fair. Some leases base it on the amount of square footage of the leased premises that is damaged or destroyed. This is unfair since sometimes the entire leased premises may not be useable even where the damage is to a small area.

• The ability to terminate should reside in both landlord and tenant. Otherwise, the tenant may find itself bound to a lease under which it is unable to use the leased premises for a significant time. This can throw a real wrench into any tenant’s business plans.

• Beware of provisions that make the tenant liable for rent if the damage or destruction results from the negligence of the tenant. Why should the tenant remain liable if the landlord has business interruption insurance, or other similar insurance?

• Watch out for provisions that allow the landlord to terminate the lease if the damage or destruction occurs within some period of time (typically the last two years of the lease), and that allow the landlord to invoke the provision where the damage or destruction is to other buildings comprising the project but not effecting the leased premises.

• Make sure the tenant retains the right to complete your improvements following the landlord’s repair or reconstruction before your rent obligation resumes.

10. Tenant Improvements:

Now you see them, now you don’t. If improvements are to be made to the leased premises prior to the tenant’s occupancy, the tenant must understand the economic impact of such improvements and know what it will get.

• Make certain that the obligation to pay rent and other charges do not begin until the tenant improvements are complete.

• Determine whether the landlord will be designing and constructing the tenant improvements at its sole cost (a “turnkey” arrangement) or whether the landlord will be giving the tenant an allowance, with either the tenant or landlord designing and constructing the improvements (an “allowance” arrangement).

• Before entering into the lease, in an allowance arrangement, the tenant should have final space plans and estimates for the work so that the tenant is not exposed for the cost of improvements in excess of the landlord’s allowance or, at the very least, will know how much it will have to pay.

• In both turnkey and allowance arrangements, the tenant must be certain to work with a competent broker and space planner to make certain that the space will be built out to satisfy the tenant’s needs.

• Where the landlord does the design work, reserve the right to look at, review and approve all designs and materials utilized, and the right to make changes up through the design stage of the tenant improvement design documents.

• Additionally, in an allowance arrangement, make sure that the allowance will not be used up for base building work, such as bathrooms located in common areas, asbestos abatement, or sprinkler systems.

• Agreement should be made as to the disposition of the landlord allowance if the actual tenant improvements cost less than the allowance. The landlord would like to keep the unused portion of the allowance, but the tenant should attempt to get the landlord to apply the allowance to the costs of other work that is the responsibility of the tenant under the lease or work letter, pay it to the tenant, off-set it against future rent, or allow the tenant to use some portion of it.

• Negotiate remedies for landlord-caused delay and carefully define and limit the consequences of tenant-caused delay.

Source: Robert C. Nicholas, Esq., Partner, Haas & Najarian

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