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Office building reflection

Commercial Landlords Are Offering Concessions As Demand for Office Space Wanes

Sep 22, 2020 by Maurie Backman
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The coronavirus pandemic has taken quite a toll on office buildings. With so many companies shifting to remote work setups and making plans to stay that way well into the future, it's easy to see why commercial landlords may be in a panic. Not only might they struggle in the near term to renew leases coming due but existing tenants might seek to renegotiate, given the impact of the ongoing health and financial crisis.

As such, commercial landlords are getting a lot more creative -- and flexible -- in an effort to retain current tenants and attract new ones. But how much will it cost them?

Commercial landlords are grasping at straws

Given office building tenants seem to suddenly now have the upper hand with regard to lease terms, commercial landlords are bending over backward to make them happy -- namely, by offering office lease concessions. These are largely in the form of free rent and tenant improvement allowances.

In fact, both of these concessions were more prevalent during 2020's second quarter, reports real estate services firm CBRE (NYSE: CBRE). Given U.S. office demand declined sharply during the past quarter, that strategy makes sense.

Commercial landlords also are making concessions in other ways. Some are offering more flexible lease terms and lengths. Others are including opt-out clauses in their leases, where tenants can cancel the remainder of a lease, provided they compensate landlords for the expense of having to find a replacement tenant.

All of these moves make sense for commercial landlords. But there's a concern they'll impact their bottom line in a way that's just not recoverable.

The problems of offering concessions

If landlords are quick to offer free rent -- an option tenants may be gunning for, given today's general economic uncertainty -- they'll risk falling behind on their own mortgage obligations. Being flexible with lease durations is perhaps less risky to some degree -- at least that way, landlords are guaranteed revenue for a limited period of time, as opposed to grappling with extra vacancies.

But still, the more concessions landlords make, the more income they stand to lose. Eventually, that could prove problematic.

Being flexible with lease terms also sets the stage for conflict once the pandemic is over. Tenants enjoying perks like free rent and customizable lease terms may not react well if things change once the coronavirus crisis is far behind us and landlords begin to have the upper hand. But that's a risk landlords may need to take right now.

The bottom line

If leasing activity continues to fall, office building landlords could wind up in a serious financial bind. So despite the risks, offering more concessions may actually be extremely prudent.

This especially holds true in markets that have been most impacted by the pandemic, like New York City, where many of Manhattan's once-bustling office buildings are now sitting empty, just waiting for signs of life.

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Maurie Backman has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.