Jonathan Keyser is the founder of Keyser, one of the largest occupier services commercial real estate brokerage firms in the nation.
Traditionally, recessions have provided exceptional opportunities for tenants to secure favorable commercial real estate terms. During the Global Financial Crisis, commercial property values dropped and vacancies increased. That combination led to high competition for available tenants, leading to lower base rents and greater concessions. In today’s pandemic-recovering society, landlords aren’t hurting as much as they were in 2008. While vacancy rates are high, property values haven’t fallen much due to government stimulus and overall inflation.
Where we are seeing softening is around landlord concessions, as landlords seek to keep their asking rates but provide significant concessions to bring down the effective rate of the deal. They typically come in the form of significant free rent and above-market tenant improvement allowances. This abated rent can sometimes be up to a full year or longer.
According to Trading Economics, the U.S. inflation rate has skyrocketed to 5.4% as of June 2021, “hitting a fresh high since August of 2008.” These rising inflation rates are causing business leaders to shift their strategies and available cash flow to account for additional costs.
To counteract inflation, business leaders have two options — reduce costs or increase revenue — which can be done in three ways.
1. Adjust the cost per employee: This path is challenging, especially in today’s economic environment. With a minimum wage over double of what it was in 2008, businesses, specifically small businesses, are struggling to meet the requirements. According to USA Today, “In 2019, the NFIB Research Center found that a federal $15 minimum wage would kill 1.6 million jobs. More than 55% of the job losses would be at small businesses, and nearly 45% would be at the smallest firms.” Labor regulations make it difficult to cut costs without also cutting support. This can cause a domino effect, meaning that the fewer workers that a company employs, the more responsibility falls onto them. When workplace frustration becomes too much to handle, workers often seek employment elsewhere. Especially in times of labor and talent shortage, this can create a critical problem for businesses.
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2. Raise the sales price of goods or services: This is an obvious next choice for many businesses. If sales are frequent, a small increase can balance out the additional costs. If you’re in a highly competitive market, have a product that is not well-differentiated or have to battle with e-commerce competitors, keep in mind that a small change may make the difference between consumers purchasing a competitor’s product over yours.
3. Eliminate some operational or commercial real estate costs: Because of the increase of technological capabilities and availability, many businesses are taking this path. Downsizing or relocating can provide exceptional business advantages. The work-from-home movement has provided a win-win solution for business leaders and their employees. Employees gain flexibility, while employers can also cut operational and commercial real estate costs. Most companies may still need some physical space to conduct their business, but downsizing can be just as effective. Since many landlords are still in a decent financial position regardless of rising vacancy rates, tenants are struggling to receive the same stellar terms that were offered during the last recession. If your business is within 24 months of the end of your lease agreement, it’s time to start considering your business’s next step.
Having had the opportunity to negotiate hundreds of commercial real estate deals for tenants and business owners since the start of the pandemic, I’m seeing one strategy yield better results for tenants than any others, assuming the tenant is willing to be flexible. It is critical to create negotiating leverage with your existing landlord if you are interested in potentially staying in the building, namely letting your landlord think you’re considering relocation. Without the added pressure of competition, landlords see their current tenants as sitting ducks, counting on them to default into a renewal or renew their lease at the same terms as previously negotiated. When tenants pose the possibility of relocation, landlords are forced to see the cost of losing a tenant and will likely offer competitive concessions.
Without active competition or the fear of losing a tenant’s income stream, landlords will offer nothing, which is why it’s always in the tenant’s best interest to keep their options open and cards close to their chest. During negotiations, it’s more important than ever to strategize and keep that strategy under wraps. And keep in mind that when it comes to partnering with an advisor who represents both tenants and landlords, their fiduciary responsibility ultimately lies with the landlord, putting your leverage and negotiation strategy at risk. For tenants, there’s a huge advantage to negotiating commercial real estate terms in a recession. You just need to know how to create leverage.