Hedge Against the Market Pendulum Build Tenant Loyalty for the Inevitable Downturn
October, 2007

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By Stephen J. Bronetto

The commercial real estate industry is booming. Robust economies are driving business expansions and the demand for new and existing office space is on the rise. Real estate markets across Canada are experiencing increased rates and lower vacancies. As a result, tenants are finding fewer space options available and discovering landlords who are reluctant to compromise in a landlord driven market.

Tenants may be surprised by the unfavourable impact of the current market conditions on their businesses. In such times it remains essential for landlords to maintain high tenant retention levels and foster open relationships with their tenants.

It is important to maintain a constant and clear level of communication with tenants before their leases are up for renewal. Owners should keep tenants informed of ongoing space opportunities and impending changes within their buildings. This helps avoid unwanted surprises and vacancies.

Every tenant has the same office space goal, which is to minimize real estate costs while maximizing revenues. Landlords should strive to understand the tenant's quantitative and qualitative objectives as well as the relative importance of each in the decision-making process.

RETENTION REMAINS A PRIORITY

Landlords should gauge their tenants' space requirements. Discuss whether relocation within the building could be a cost-efficient alternative to relocating to another building. This type of win-win outcome creates a proactive working relationship for both the landlord and the tenant that truly saves money.

Only a few years ago, landlords were renting space at highly competitive rates rather than let a building sit vacant. Any tenant, even a marginal one, was better than no tenant at all. Now that the market has turned to the landlord's favour, tenants have less room for negotiating. In some cases, tenant concessions and improvement allowances are reduced or even nonexistent, while abatements of rent are a thing of the past.

Nevertheless, the pendulum swings both ways. Eventually tenants will be seeking a payback position in a tenants' market.

If landlords are proactive, they will do whatever they can to retain the tenants in their buildings through each type of market - providing amenities such as the latest communication options and topnotch service. This creates more incentive for to stay loyal to the landlord.

Profits that landlords gain today can eventually be eaten up in vacancy, extensive improvement costs, marketing and higher commission costs. A strategy of acquiring reasonable long-term return while maintaining a full building can be a hedge against the swinging cycles of the market.

Surveys of tenants indicate that they are often open to taking future growth space within the same building and under longer terms. Thus, the value of the building could remain consistent year to year without wild vacancy fluctuations.

REASONABLE LONG-TERM RETURNS

A consistent cash flow is superior to market vacancy fluctuating cycles because overall returns will become more predictable and sustainable.

However, tenants will likely have a strategy to deal with their next office leasing negotiation. Eventually interest rates will rise and capitalization rates will compress, and alternative investments will garner increased investor attention. Expensive land prices, increasing construction costs and a lack of development locations will inhibit development of new office buildings.

Already there are hints of a potential economic downturn that could affect the office market.
Forecasting potential rate changes requires a strong understanding of market dynamics and open dialogue between landlords and tenants. This can create a more desirable working relationship between landlords and tenants before the shift from landlord to tenant market happens again.

Landlords and tenants are on something of a roller coaster that is going up and down. Managing tenant expectations can make the ride much smoother.

Stephen J. Bronetto is President of BonaMax Realty Inc, specializing in strategic planning, acquisition/disposition and leasing in the commercial, industrial, retail and real estate investment sectors. For more information see the web site at www.bonamax.ca.