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Survival Kit for Landlords

The challenging economic climate marked by shaky financial institutions and increasing unemployment is resulting in rising vacancies and falling rents in today's commercial real estate market. The pendulum has swung in favor of tenants and likely will remain there throughout 2009.

Landlords need to take a number of steps to protect their assets when dealing with existing and prospective tenants. First and foremost, landlords need to adjust their thinking in the short term to maintain a steady cash flow and position their assets to weather the recession.

More than ever, tenants are looking at gross occupancy costs, or net rent plus their share of the operating expenses. Tenants historically have focused on net rents, but the operating expense portion is coming under increased scrutiny as the recession deepens.

There are several options that owners should consider to reduce operating costs, all of which can lower tenants' costs of occupancy.

  • Aggressively contest real estate taxes by arming yourself with information that could help your tax attorney and the assessor. A building may have lingering vacancies or unique challenges that the assessor hasn't considered.

  • Consider making your building more “green,” which may include Energy Star and LEED certification. Landlords should pay attention during the next few months to what's included in the government's stimulus package in the event the program offers incentives for property owners. However, there already are big incentives from utility companies in every geographic market.

  • Take advantage of group purchasing to lower operating expenses, including property insurance, utilities, janitorial services and trash removal. Landlords can receive significant discounts by leveraging the size of their portfolios managed by their service provider.

  • Don't sit on a request for proposal (RFP). Your responsiveness may set you apart, especially if you understand what's important to that tenant — from parking to amenities to lower utility costs. A quick turnaround shows a commitment to the customer.

Also, put on the “full-court press” when showing a building to a prospect. In addition to having the leasing agent at showings, consider including the property manager and the building engineer in case a prospective tenant has questions.

If the space needs significant construction, bring in a construction representative. You don't want to miss your opportunity during the 15 minutes you have with the prospect.

Tenant representative as ally

Tenant rep brokers are not the enemy, and can be an important friend. A tenant rep broker is hired by tenants to help define their space needs and negotiate lease terms with the landlord. Today, more than 80% of all tenants are represented, and that percentage is even higher on large transactions.

Landlords must understand that most tenant rep brokers are not simply looking for a commission. They can help place the landlord's building in the best light to leverage the building's advantages. Treating a tenant rep as an extension of your leasing team can pay dividends.

Most landlords today are in an “asset preservation” mode rather than positioning the building for “value creation” in the next 12-18 months. Even if the objective is to position the asset to sell it in the years ahead, landlords can meet the market now by focusing on shorter-term leases. When the market recovers, landlords can return to a more aggressive strategy of building long-term value.

Minimize vacancies

In better times, a landlord could buy a less than fully occupied property on the assumption that he could lease it up quickly, but that's no longer realistic. Typically, landlords pay the cost of operating expenses on vacancies, which can quickly erode the building's cash flow. By generating enough rent to pay operating expenses the owner protects the downside and limited vacancy carry costs.

It's important to acknowledge requests for rent reductions, but also ask to see a tenant's current financial statement and a business plan showing how it plans to recover. If the tenant is a good long-term risk, consider exchanging rent relief for an extension of the lease term.

Despite challenges, investors can protect or even improve their building's value. With the right approach, investors can weather this storm and be well positioned when the skies clear again.

Jeff Eaton is president of Minneapolis-based NorthMarq Real Estate Services. He can be reached at [email protected].

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