Tenants have the upper hand in the current commercial property market: Simon Crouch

In the current economic climate tenants in the commercial property market – rather than landlords – have the upper hand.

Tenants are increasingly looking at the bottom line and with landlords keen to retain tenants, there are opportunities for tenants to negotiate a better deal.  

Tenants are continuing to examine their entire business to identify where cost savings can be generated and given that one of the major costs to all businesses is the premises they operate from, this is a good place to start. The current economic conditions have created a tenants’ market, so now is the time for tenants to examine every space their organisation occupies and explore the strategies available to reduce risk, maximise operating efficiency and drive down costs.  

This market provides the perfect opportunity for tenants to reposition and enhance their businesses and this can be done primarily through workplace improvement and upgrades.  

There are several ways in which office tenants can benefit in the current market, and the best way to capitalise on the opportunities is to outsource property requirements to experts. Tenants need to be aware of what is on offer so they do not simply exercise an option or sign another long-term lease without looking at the options available.  

In this type of market landlords are keen to retain or secure tenants on long-term leases to guarantee income and extend their Weighted Average Lease Expiry (WALE), so any tenant with two years or less remaining on their lease should look to engage with a tenant representative now to ensure the best outcome. There are opportunities, for instance, for tenants to renegotiate or restructure their lease and receive a significant cash incentive from their landlord for extending. There are numerous examples recently where 100 % of a tenant’s new fitout was covered by well negotiated incentives.  

In addition, there are often additional incentives left over from the fitout to be contributed towards rent reductions or rent free periods. Many tenants whose fitout, building and location meets their needs may elect to allocate the entire incentive towards rent to drive down operational costs.  

The best opportunities for tenants at the moment are in the Sydney and Melbourne CBDs, as this is where incentives for office space were proving to be the highest. Incentives in the Sydney CBD range from 22% to 30%, with B-grade space in the southern precinct having the highest incentives of 28% to 30%. There are instances in particular buildings with large vacancy where incentives are pushing above 30%.  

The Melbourne and Brisbane CBDs are not far behind, with incentives ranging from 20% to 30%. Meanwhile, incentives in the Adelaide CBD range from 5% to 20%, in the Perth CBD they range from 5% to 10% and in Canberra they range from 8% to 20%.  

While tenants clearly secure a benefit from incentive arrangements, it is not only the tenant who benefits. It is a win-win for the tenant and the landlord, as the landlord retains or secures a tenant on a long-term lease, locking in their cash flow with no let-up time. The opportunity cost of a tenant vacating is significant, with let up time for larger space between six to 18 months in addition to building upgrades required to attract new tenants.  

As well as securing incentives, office tenants also have the opportunity to negotiate on clauses in their lease agreements that are more difficult in an environment that favours landlords, such as rent reviews, expansion/contraction clauses and ‘make good’ provisions. This type of flexibility is essential for tenants in the current economic climate to enable growth and contraction to meet an organisation’s changing needs. The office environment will need to be able to adapt to the changes in the business over the entire lease term, which includes being able to expand or contract the head count in the same amount of space.  

Tenants have a further opportunity to approach landlords to make upgrades to their buildings – for instance bathroom, air conditioning, lighting, carpet or lobby upgrades. Landlords are likely to cooperate when it comes to these requests, given their desire to retain tenants and ensure their asset remains competitive in the market.  

One of the other major benefits of the current market for tenants is the opportunity to snare a newly refurbished space for great commercial terms. Due to an increase in new supply in most markets over the next two years, a major trend will be an increase in backfill space due to large tenants consolidating their operations and moving into new developments providing superior quality accommodation. We will see this for instance with Westpac, and KPMG moving in to the Barangaroo development. As large tenants move to new spaces, landlords will be forced to upgrade their buildings through refurbishment to attract new tenants and they will also be forced to offer high incentives for the backfill space to attract tenants.  

Over the past six months we have already been witnessing a significant increase in activity in the sublease market - better sublease space is being made available in the wake of major companies reducing headcount and seeking operational cost savings. Consequently this space is competing with new space that is available at greatly reduced rentals, often with high quality fitouts included in the offering.  

In addition to negotiating with their landlords to get a better deal, tenants looking to save money should also look at reconditioning the workplace to potentially create greater efficiency and reduce the space required to operate. Lease expiries give tenants the opportunity to reconsider their accommodation needs and explore ways to reduce their footprint to save costs.  

Tenants looking to consolidate their operations should look at how their existing workplace supports their business strategy and consider whether their work settings actually support the ways their teams work. For instance, it might be worth evaluating whether every employee actually needs a designated desk. We find that typically, just over half the available desks are in use at any one time in an office. It is rare for staff numbers to break an 85% occupancy rate, which means many businesses may have more space than they actually need.  

Workplace technology is another area where businesses can make savings. For instance, most organisations will only update their telephony systems and update their network infrastructure when they are relocating. This means long-term occupiers could be losing their competitive edge by failing to provide technologies that enable workplace mobility. Technological mobility is a major consideration for businesses looking to consolidate as it allows greater density within an existing footprint.  

Simon Crouch is national director of tenant representation at Colliers International.