How Puget Sound area office tenants can ink the best lease in more than a decade
Tenants with insight into the market, who effectively time their decisions, and competitively leverage the Seattle office market will be rewarded with the best office lease in over a decade.
The Covid-19 pandemic has caused an historic disruption to Seattle area’s dramatic 12-year office market expansion. Prior to the pandemic the market was on a tear with Bay Area companies gobbling up high end office space. Average asking rent had grown by 56% over the past decade. That’s all changed as companies have responded to the pandemic with work at home strategies leaving much of the region’s office space vacant today, as we head into the softest market since 2008 and rent growth at a negative 4% for the past year.
What can Tenants expect in 2021?
Vacancies will rise and asking rents will plummet. Here is why: In the past 12 months a record 6.3 million sf of sublease space has been put on the market. When added to the inventory of direct space, the 2021 year over year total market vacancy rate has already increased by a whopping 40% and is in double digits for the first time in recent memory! Add to that the additional 2.3 million sf of vacant new construction hitting the market and you have the makings for an even softer market in 2021.
Most deals today are loaded with free rent and other concessions with landlords for the most part still reluctant to give on face rental rates given how exponentially their building valuations are tied to face rental rates.
You can expect rents to drop as the markets inevitable decline continues to soften rents over the next 6–18 months. One key metric to watch will be the widening spread between sublease space and direct space. An another will be the growing amount of total vacant space in the market. These two trends will leave Landlords no other choice than to more aggressively discount their asking lease rates.
Here is what I predict
First half 2021 — office market remains in stagnation– With tenants cautiously awaiting widespread inoculations before returning to work, you can be assured that tenant demand will remain virtually non-existent through mid-year 2021. The majority of deals will be a continuation of 2020 “wait & see” transactions largely limited to lease renewals, downsizing and tenants opting for shorter lease terms. This downsizing trend that started in 2020 will continue in 2021 resulting in accelerating negative net absorption of space. At the same time, sublease space will continue to grow.
Market stagnation will lead Tenants holding sublease space to more aggressively discount asking rental rates. Sublease asking rents have dropped by 10% over the past year compared to 5% for direct space. As this spread increases in the coming quarters professional Landlords will be forced to react by doubling down on concessions, more free rent, higher tenant improvement allowances, and higher broker commissions.
Second half 2021 office market with price discovery -The second half of 2021 will be a time of price discovery for the market as post vaccine tenant demand will gradually start to reappear. These nascent signs of tenant demand will motivate Landlords to join Sublessors in dropping rents further to fill empty space.
Faced with over a year of stagnating market conditions and growing competition from the sublease market, Landlords will more aggressively discount rents Q3-Q4 to attract higher quality tenants in the market.
Tenants can therefore expect to see the biggest drop in rental rates and greatest concessions for 2021 during the second half of the year.
How tenants can take advantage of the market:
Timing is everything in real estate and more so when the market is in transition. With respect to lease negotiations, tenants should have two goals in managing their time: First and foremost, tenant should have plenty of time to negotiate their deal by getting into the market well in advance of their need for space. It’s important to negotiate in advance of any internal deadlines and avoid being forced to settle for a suboptimal deal. Secondly, they will be better off delaying major space commitments to the 2nd half of the year, if possible. This will help Tenants both have better optics into their own needs and be in the market at a time when Landlords are most motivated by the market to cut deals.
It is important for tenants to have current market information. For example, one of the dynamics of Covid-19 has been to push demand from the CBD to the suburbs. So it’s important for Tenants to have different expectations for suburban Bellevue than downtown Seattle.
Lease comps are also rapidly changing as the market continues to slide. Knowing the most recent rental deals will keep Tenants from losing out. Equally, Tenants should know what motivates the ownership of the property they are negotiating and what they can deliver in a lease transaction. Some owners are more concerned with current cash flow and others are looking for rental increase to boost the property valuation. Knowing the ownership priorities will help Tenants qualify the subject landlord ability and willingness to cut a great deal.
Sublease space can be a good interim option for tenants that need better optics into the future before committing long term. Tenants can get shorter leases that are sometimes outfitted with furniture, but they need to be cautious and take steps against the potential for credit risk and possible default by their sublessor.
The most effective way for a tenant to capitalize on the weak market will be to leverage the competition. This is done by simultaneously managing several negotiations and not prematurely zeroing in on one property. The result is both leverage and “walk-away” power. While this may seem incredibly obvious, you would be surprised how many brokers miss this critical point. IN my experience today. most brokers may send out a handful of RFPs, but then lose valuable leverage by prematurely focusing on a single property. While this may have been their standard operating procedure in 2019, the rules have shifted in 2021. The last tenant market was in 2006–2008, so many of today’s brokers have never worked in a tenants market and have no idea how far they can push a deal with appropriate leverage. It therefore behooves tenants to find a broker with at least 12 yrs experience in the marketplace who knows from experience how much they can achieve for their clients in a true tenant’s market.
In addition to experience, the qualified tenant’s broker should commit to helping tenants leverage the market. Most brokers in the market fail in this regard by accepting the inherent conflict of interest of trying to serve two masters and routinely represent both landlords and tenants. While this business practice may be very profitable for them, there is no reason for you, the tenant to settle accept this compromise and a resulting subpar lease transaction. The best way to get a real opportunity to leveraging the market to the fullest is to hire a broker that only represents tenants and eliminate this conflict.
2021 will be challenging year for all of us but the silver lining for Seattle area tenants is that they will be entering one of the best years to make a lease transaction. There will be plenty of high-quality space available with eager Landlords and Sublessors ready to deal.
Savvy tenants will have the opportunity in 2021 to time their decisions and have well executed and informed lease transactions that leverage the market. The best way to do this is to find an experienced broker that only represents tenants and can help them make the best lease deal in over a decade.
About the Author: Eric Postle is the Managing Principal at ITRA GLOBAL- Seattle, an organization dedicated to representing the best interest corporate tenants and occupiers of commercial real estate in major markets across the globe. Eric can be reached at firstname.lastname@example.org or 425–830–3000.