Space Race

The weak real estate market offers CFOs a great opportunity. Here's how to maximize it.

The Window Is Wide Open, for Now

Those conditions are not expected to change for the next 12 to 18 months, says Manley. According to her research, the average U.S. vacancy rate is 15% in large urban areas and between 13% and 17% in suburban areas, even surpassing 20% in some suburban markets. A 10% vacancy rate is customarily regarded as equilibrium, offering equal bargaining power between landlords and tenants.

High vacancy rates aren’t the only factor giving current and prospective tenants the upper hand. Other considerations include commercial real estate availability — space that will become vacant within the next 12 months — and “shadow space,” an industry term for space under lease that isn’t being used.

“Right now in New York City, the availability rate is about 13%,” says Manley. “We estimate the shadow space at about 3%. You add all this up, and in the near term the effective vacancy rates are much higher than they appear. And this will continue to compel landlords to cut deals they’d rather not.”

“Given the high vacancy rates, the timing is good for CFOs to examine where their companies are in their lease terms,” says Ray Milnes, national leader of KPMG’s real estate practice. “If they have a 10-year lease and they’re in year 6 or 7, the landlord is beginning to feel the stress of the lease expiring and possibly losing the tenant. They know that other landlords are ready to pounce. This gives the tenant the advantage; [the CFO] can say to the landlord, ‘We have 3 years left on our lease. We like the space. What can you do for me?’”

Milnes says landlords are working with tenants to extend leases, often at lower rents, and will even provide an allowance to tenants to update or remodel the physical space. “Building owners are doing everything they possibly can to retain existing tenants because they know it is a lot harder to find new tenants than to keep the ones they have,” he adds.

Seizing these opportunities now is critical, says Robert Merck, senior managing director and head of New York–based insurer MetLife’s real estate investment department. “Now is the time to lock in a long-term lease, because rates in most metropolitan cities are significantly down from their peak,” Merck says. “As the economy begins to slowly and steadily improve, vacant space will lease up quickly, since there wasn’t as much speculative building prior to the downturn, translating into less overbuilding. The window of opportunity for leasing at attractive terms should remain open for the next 18 months, maybe even two years.”

Bill LaFayette, who follows national commercial real estate trends as vice president of economic analysis at the Columbus Chamber of Commerce, says the window may slam shut sooner. “Office space is driven by employment, and the forecasts now for the general economy point to a gradually increasing rate of GDP growth that should be north of 3% by the end of 2011,” LaFayette explains. “That is a strong-enough growth rate to drive employment growth. Once that picks up, demand for space will rise and the leverage that tenants now have will slacken.”

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