Tenant Occupancy Costs Register Record Decline
Concessions Spike, Floor for Net Rents Reset to 2005 Levels
New York, NY (April 21, 2010)  
Based on the just released 2010 Studley Effective Rent Index (SERI), businesses that signed leases in 2009 locked in generational savings as effective rents registered their steepest decline in decades.

Tenant effective rents (the cost of occupancy for tenants) fell by 23.8 percent during 2009, decreasing from $51.14 to $38.98. This was the largest year-on-year decline since the SERI index started in 1995.  Tenant effective rent has fallen by 29.2 percent from its peak of $55.02 in 2007, and is now just below the $40.00 rate in 2005.

Occupancy costs dropped in every market with declines of more than 10 percent in nine of the 17 markets tracked. Midtown Manhattan (-40.2 percent); San Diego (-34.9 percent) and Miami (-31.0 percent) posted the steepest decreases as demand evaporated and sublet space surged in these markets. In 10 of the markets, tenant effective rents fell at a more moderate rate of less than 20.0 percent. In four of these markets – Denver (-1.2 percent), Philadelphia (-1.8 percent), Washington, DC (-12.3 percent) and Houston (-16.2 percent) – the relative stability can be attributed to healthier demand or more limited supply of quality product. Denver’s and Philadelphia’s CBDs, for example, both have a small supply of premium product, and compared to other markets, lay offs from the recession were not as significant. Sublet supply consequently increased but not to the extent seen in Los Angeles, Chicago or Manhattan.

On the other hand, in markets such as Tampa Bay (-5.8 percent), New Jersey (-6.5 percent), Chicago (-7.9 percent) and Atlanta (-10.9 percent), tenant effective rent was already well below the national average heading into 2009. These markets had already experienced rent deflation in 2007 and 2008, and landlords had little margin left to squeeze out lower net rents or increase concessions. In Atlanta, for example, tenant effective rent was just below $18.00 in 2008 – the lowest it had been on a non-inflation adjusted basis since the mid-1990s. This rate fell to$16.04 in 2009.

Landlord effective rents (the landlord’s bottom line less expenses, concessions and commissions from total rent) also registered their sharpest annual decrease yet – plunging by 41.4 percent from $29.21 to $17.11. Landlord effective rents have dropped nearly 50.0 percent from their peak rate of $33.63, and the index is just above the $16.06 rate recorded in 1997.

For the first time since 2003, Midtown Manhattan was pushed off the top of the scale, supplanted by San Francisco and Washington, DC. The median landlord effective rent (San Diego) fell from $23.88 to $11.76 in 2009, and the highest landlord effective rent (San Francisco, $28.60) fell below $30.00 for the first time since 2004. Chicago and Atlanta were in the bottom two positions for the second straight year.

Effective rents plummeted because the starting point for rents – net or base rents – collapsed, and the value of concession packages soared.

Net rents were reset in nearly every market, plummeting by 26.9 percent nationally. Net rents plunged by more than 30 percent in the markets that had the most room for adjustment such as Manhattan and West Los Angeles.

Markets covered in the report include:  Atlanta, Chicago, Dallas, Denver, Downtown Los Angeles, Downtown Manhattan, Houston, Miami, Midtown Manhattan, Northern New Jersey,  Orange County, Philadelphia, San Diego, San Francisco, Silicon Valley, Suburban Washington, DC, Tampa Bay, Washington, DC, and West Los Angeles. Chicago, Atlanta and Tampa Bay posted moderate declines in net rent of less than 10 percent, however all started with razor-thin operating margins.

Only a few markets – Denver, Philadelphia, Washington, DC and Houston – experienced little decline in effective rents as a result of the relative stability of those markets.

In addition to lowering net rents in 2009, landlords also increased the value of concession packages to levels not seen in decades in most markets.

The value of concession packages reached record levels in 2009 in all but four markets. Every market except Philadelphia (up by only 7.1 percent) posted a double-digit increase in the value of concession packages. Values pushed above $100 per square foot in four markets:  Chicago (+16.7 percent to $105.00); Atlanta (+18.2 percent to $105.00); Midtown Manhattan (+22.3 percent to $115.00) and Washington, DC (+87.1 percent to $131.00). These numbers do not include the unquantifiable but valuable concessions, such as expansion, contraction and termination rights, lease buyouts and building signage. A cross-market comparison of negotiated concessions included in the report’s Supplementary Info section (PAGE 52) shows that concessions, as a percentage of the initial year’s rent, were generally much higher in suburban markets than in CBDs. In CBDS, the value of concession packages as a percentage of initial year rent in Chicago, for example, was roughly twice its value in Midtown Manhattan and West LA.

In some cases, landlords agreed to lease terms that yielded a negative cash flow in the initial years to get space filled.

Though the SERI index only tracks direct transactions, the flood of sublet space and the highly favorable terms granted by many sub-lessors exerted significant pressure on all property owners to follow suit, setting a new standard for how low rents could go,. Many subleases signed for quality space had significant term remaining and included high-end installations.  Some sub-lessors, many from the financial sector, adopted a lease-at-any-cost approach to unloading space. Landlords, with the capacity to take a cut in their bottom line, made aggressive moves, while others were restricted by financial obligations, pro forma rent goals and/or depleted reserves that prevented them from lowering rents or extending competitive concession packages. 

As 2009 ended, the downturn was moderating, with some markets showing signs of recovery. The Supplementary Info section of the Report, which shows key employment trends in 2009, also charts key commercial real indicators.   Leasing activity, in the second half of 2009, showed tentative signs of improvement with the flow of sublet space ebbing and a more moderate decline in asking rents.

Although the downturn appears to be losing momentum, most markets have several years of available space to work through, explained Steve Coutts, SVP, National Research Services for Studley.  “Availability is not likely to change much until a majority of firms shift from renewals to more opportunistic leases involving expansions. The trajectory of job growth in 2010 and 2011 will determine whether it takes a couple of years or five years for rents to rebound. The consensus view for most economists is that employment growth will be subpar in 2010 and 2011.”

Tenant occupancy costs in most markets will decline further in 2010, but the decreases will probably be in single-digits rather than the extreme drops seen during 2009. An additional 10 percent decrease in tenant effective rents would push tenant occupancy costs just below their mark in 2003.

Concessions should also remain favorable for most tenants through the year. Landlords will likely start to pull back on concessions in particular submarkets, or at segments of the market that are tightening.

About Studley.
Studley is the only global tenant advisory firm with a pure tenant representation delivery platform. Founded in 1954, Studley pioneered this conflict-free business model. Today, with 19 offices nationwide and an international presence through its London office and AOS Studley throughout Europe, Studley provides strategic real estate consulting services to top-tier corporations, law firms, nonprofits, government agencies and institutions of higher education. Information about Studley is available at www.studley.com.