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What does the Pirates Code and Asking Rents have in common?

5/1/2023

 
“The code is more what you call guidelines than actual rules.”
 – Captain Barbosa explaining the Pirates Code

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Like the Pirates code, asking rents are guidelines that landlords and their brokers give tenants as a customary starting point for rent negotiation. But don’t confuse asking rent guidelines with reality.
 
On March 17, 2020, San Francisco issued a stay-at-home order. According to CoStar, average office asking rents on that date in the San Francisco metro market were $64.55/RSF and total availability was near market equilibrium at 9.9%.
Three years later, San Francisco has the highest sublease availability rate in the country. On St. Patrick’s Day 2023, market uncertainty caused by the pandemic had more than doubled total availability to a staggering 23.7%.
 
In the slow recovery from the pandemic San Francisco, with a large population of work-from-anywhere friendly companies, sits at the bottom of major metros nationwide in return-to-office rates. That, together with tenants moving to cheaper markets translates to lower demand for office space now, and potentially fewer office workers in the future.
 
Yet, contrary to the market reality caused by the pandemic, landlords have held on tightly to pre-COVID asking rents.
On March 17, 2023, asking rents in the San Francisco metro market were down only 4.7% from the stay-at-home order of 2020 to $61.50/RSF. ​
 
The Market Reality
 
For the first time in a decade, tenants have gained negotiating leverage created by two years of pandemic. As tenant representatives we work exclusively with tenants. Never landlords. We recently negotiated a $32.00/RSF direct lease for Class B office space in San Francisco that had a 2020 starting rent of $56.00/RSF. Now, a 42.9% drop in negotiated rent from pre-pandemic may be an outlier but unlike some San Francisco asking rents, it’s to be believed. 
 
Why are Asking Rents out of sync with Market Reality?
 
One of the dirty little secrets of the commercial real estate industry is that most big national brokerages represent both landlords and tenants. It is in the best interest of the brokers representing landlords to keep perceived rental rates as high as possible. Like the Pirates code, these asking rents are guidelines that aren’t to be trusted.
 
Brokers that specialize in tenant representation are only focused on finding value and multiple alternatives for their clients. Properties with unrealistic asking rents tend to come in with higher rent proposals than equal and comparable buildings. Fortunately, some San Francisco landlords are starting to break ranks with their peers and are setting more realistic asking rents. If you find a landlord looking to gouge you on rent before a lease is negotiated, consider yourself lucky to have identified the bad news early. Then, move on to a more realistic alternative.

What Every California Tenant Should Understand About Property Tax Liability

12/4/2020

 
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As tenant representatives, we advise our clients that ownership matters. The differentiator between two similar buildings and spaces with like amenities and rent can often come down to the quality of ownership. Buildings that have been owned and managed by the same entities for a long period of time tend to be better managed.  

 Under Proposition 13, buildings like these may not have been reassessed at market value for years and in some cases decades. Proposition 13 was approved by 65% of California voters in 1978 and currently limits property tax reassessments (increases) to 2% annually but allows for full tax reassessments if the building is sold, more than 50% is transferred, or substantial new construction is completed. 

In California, commercial landlords typically pass on a pro-rata share of building operating expense (OPEX) including property taxes to their tenants. In the most common “full service” office lease, tenants are only responsible for OPEX increases over the “base year” amount which is most often the year of the commencement date or the year following the commencement date. 

​As a result, tenants in buildings that have been owned by the same entities for a long period of time carry a large tax liability if the property is sold or transferred during the term of their lease. In San Francisco, tenants with the largest pass-through liability are looking at as much as $10 per square foot per year for the remainder of their lease if the property is sold and reassessed.

 Why is property tax liability a third rail issue for brokers?

The differentiator between two similar buildings and spaces with like amenities and rent may come down to the size of a tenant’s property tax liability. For this reason, w
e do the math on the property tax liability for every alternative we put in front of our clients.

As a brokerage working exclusively for tenants we always pursue some level of protection for our clients by seeking a cap on OPEX (including property taxes) increases throughout the term of the lease. Not having cap on property tax increases can be devastating for tenants but building owners are extremely resistant to agreeing to this protection. Simply put, commercial property is harder to sell if tenants have OPEX caps. So, it’s understandable that landlords are somewhat inflexible and seek to pass the full tax reassessment burden onto tenants. 

 
For the last decade only the largest tenants in softer markets have been able to negotiate caps on OPEX increases. But a black swan event like the coronavirus pandemic shifted leverage in markets that once favored landlords to favoring tenants overnight. Seeking and obtaining OPEX protection is easier said than done but it should always be subject of negotiation. 
 
Somewhat harder to explain and understand is why property tax liability is a third rail issue for brokers. The dirty little secret in commercial leasing is that most commercial real estate brokerages represent both tenants and landlords which creates a built-in conflict of interest. If your broker isn’t discussing your property tax liability or seeking a cap on OPEX, it’s probably because like a third rail, touching it is extremely dangerous for their business.  
 
At a minimum, it’s important to do the math on your property tax liability before entering a lease in any building in California. Tenants need to know when the property was last reassessed for Proposition 13 purposes, what its assessed value was and what its assessed value is today to forecast the potential liability due to a transfer of ownership. The longer it’s been since the last reassessment, the greater your exposure to property tax increases.

Coronavirus Pandemic Has Shifted Leverage from Landlords to Tenants

3/26/2020

 
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The commercial real estate market was flying until it suddenly wasn’t. After more than a decade of growth we knew the day would come when the office market would weaken. What none of us saw coming was a black swan event like the coronavirus pandemic where a market that once favored landlords shifted to favoring tenants in just days. 
 
Every business in the world is developing plans for coping with the sudden economic uncertainty. With no lead time companies have been forced into experimenting with employees working from home. Unfortunately for some companies and their employees the coronavirus outbreak has already led to layoffs and furloughs.
 
After staffing cost, real estate is the largest expense for most businesses. At some point soon every company is going to look at their office lease obligation and ways for reducing that cost. 
 
The first step is to do your homework. Study your lease to understand what rights you may have to make lease changes. Audit your lease and operating expense history to evaluate if you have been overpaying. Consider bringing in a planner to right-size your space if operationally it no longer fits.
 
Then, together with your tenant representative, work with your landlord. Share with your landlord that you are seeking rent relief and are considering several options to mitigate your lease obligation. 

Sublease
 
If you need to downsize your current space, and provided your lease allows for it, listing your space on the sublease market is one way to reduce your rent cost. Companies that have suddenly found themselves with excess space are already listing their space for sublease and dropping sublease rates 20% to 30% to get their space filled quickly. 
 
Landlords want to avoid competing with multiple below market sublease listings for empty space in their buildings because a sudden flood of sublease inventory deflates the building’s overall rental rate. The possibility of another sublease in the building could also make your landlord more willing to work with you on restructuring your lease. 
 
Restructuring
 
One of the tightly kept secrets in commercial real estate is that your lease obligation is negotiable. There are two variables in your rent cost calculation. Rate and rentable square footage (RSF). Both are negotiable by either a rate reduction or contraction (giveback). 
 
Most dual agency brokers will deny it but brokers that only represent tenants know when negotiating leverage shifts from landlords to tenants, landlords suddenly become more willing to consider restructuring lease obligations. Why? Because in uncertain economic times landlords know that no one will be standing in line to pay your current rental rate for the entirety of your empty office space.
 
Even before the coronavirus pandemic hit the Bay Area sublease availability was on the rise and rent growth was slipping. When the commercial real estate market was flying it would be rare to find a landlord willing to consider restructuring your lease. That’s no longer the case.
 
Termination
 
You may not have looked at your lease agreement since the day it was executed but now is the time to see if you negotiated a termination right. Depending on the termination right you may have the ability to terminate the lease contract before the expiration of the lease term. Be aware that the landlord may maintain the right to sue for damages for early termination or charge a fee for early termination. 
 
So, given the shift in leverage from landlords to tenants, why isn’t your broker enthusiastic about assisting you in seeking rent relief?
 
More than 90% of the commercial real estate brokers are dual agents, representing both landlords and tenants.  This creates a built-in conflict of interest that few tenants understand and even fewer brokers discuss.  No one would hire a lawyer who works for the other side. Yet, the equivalent happens every day when tenants work with commercial real estate brokers and firms that also represent landlords.  
 
It is in the best interest of brokers that represent landlords to keep perceived asking rates as high as possible and vacancy rates as low as possible. But, large amounts of below market sublease space softens the market. Otherwise, landlords and listing brokers would openly publish asking and actual rents on every direct and sublease space they list.  
 
In order to gain leverage and rent relief you need to first eliminate conflict of interest by woking with a broker that only represents tenants. If your broker or anyone in their office has listings in the market, they have a conflict of interest.

Then, work together with your landlord and tenant representative to explore all options for mitigating your lease obligation – sublease, restructuring, and termination.
    Kevin Cronin

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