Commercial property : Changing Spaces – The Devil’s in the Detail

Leasing commercial property is serious business that needs serious expertise, says specialist in managing the interests of tenants and lessees. And the changing economic landscape is bringing new issues into focus.
Peter Scott, chief executive of commercial property advisers Parallel Directions, observes several emerging trends, including companies staying in their existing premises rather than relocating, and perhaps undertaking refurbishment, and tenants seeking specialist advisers to help them through rent reviews, lease renewals and relocation decisions.
“Others are reducing space requirements and need assistance in disposing of surplus space.”
Scott says that in the present market commercial landlords and tenants taking hard line over lease terms could be biting off more than they can chew.
“The real risk is replay of the 1990s when tenants struggling with high overheads walked … leading to high vacancy levels… and landlords then having to offer huge incentives to attract new tenants. solution is to view any landlord/tenant relationship as partnership… both parties are affected by current market conditions.”
Scott says challenging economic times are great for sharpening thinking and that while the market might be depressed, the courageous will be thinking ahead and planning for growth when markets pick up.
“Tight money markets can alter the viability of property developments and renovations overnight. All developers – from the scrupulous to the scurrilous – can be affected. This volatile market raises the need to consider sunset clauses in leases to protect tenants if developments don’t go ahead.” Scott says such clauses won’t work in every situation and negotiation needs to be on case-by-case basis. Rent hikes during rent reviews are not something the tenant has to live with, for example. “For the majority of commercial tenants anything that adds value to the business and reduces overheads is critical… rent rises don’t have to be taken at face value.”
John Church is the national leasing manager for Jones Lang LaSalle. He says there is lack of high quality office space in New Zealand’s major centres and that the majority of new buildings under construction are already pre-leased. And with logjam of leases due to come up for renewal in Auckland between 2010-2012, he says tenants should be thinking about renegotiations now.
“It’s good to start thinking about and planning for these things at least two years out,” Church says.
In Wellington, he says, the vacancies for space are also in the lower grade premises. The Government is major tenant, obviously, and Church says it will be interesting to see if there’s change of government whether office requirements (space and style) change.
Property partners Ian McCombe and Howard Johnston at Brookfields Lawyers, note that the number and type of requests and requirements for properties is changing as the current tight economic conditions begin to bite.
“Things have changed little bit – relatively recently, in fact, in the last few weeks. Questions are being asked more and more frequently: What do you do about tenants in default? How can I get out of my lease? Tenants are also being lot more careful about their liabilities,” they say.
Clients are asking about getting as much flexibility as possible in terms of being able to drop off space. If company’s overall trading position is deteriorating they will look at where its main costs lie and rent is often major expense.
“We have also been talking to clients about assignment and sub-leasing – as options for reducing space and cost,” the pair say.
Looking more specifically at the Auckland and Wellington markets, CBRE analyst Zoltan Moricz has several observations: In Auckland, he says, the occupier market remains positive with vacancies at long-term lows and rentals continuing to post increases in most sectors in the first half of 2008.
“However, at the margins, conditions and sentiment have eased, caused by growing uncertainties regarding the unfolding of the economic cycle and its influence on demand, as well as some space coming on the market through tenancy relocations as well as finance sector contractions.”
While this has not had material impact on rentals being achieved, it is leading to greater emphasis on ensuring security of income through maximising lease length, Moricz says.
The top end of the prime rental range is currently assessed at $600 per square metre on recently achieved rent review evidence – with recent reviews showing substantial lifts in the order of 40-plus percent over the past three years. Most of this is attributed to Grade space playing catch-up on the benchmarks being set by the best quality premium grade buildings.
“Despite the general increase, the range of prime rentals is wide, starting at around $230 per square metre. This mainly reflects the importance of location within the CBD with buildings not in proximity of the waterfront being unable to match the rental growth profile of those that are,” Moricz says.
Also, he adds, the impact of leasehold tenure is growing with some substantial ground rent increases limiting net rental growth potential for leasehold properties.
His research shows that the Auckland supply pipeline for the next year or two is concentrated on four major projects due to be completed next year, ranging in size from 23,500 square metres in the BNZ building at 80 Queen Street to 8000 square metres in the Westpac building on Customs Street. Pre-commitment is strong to new projects with the exception of the 13,700 square metre redevelopment of Downtown House at 21 Queen Street.
“However, significant portion of the pre-commitment is from occupiers of existing prime CBD buildings which will have detrimental impact on vacancies of second-hand prime space,” Moricz says.
Looking at Wellington, he says the fundamentals remain sound in the occupier market, although more cautious attitude appears to be developing around making commitments to expansions and new premises.
“Office vacancy rates are around historic lows. Encouragingly, vacancies are low across the board with the prime and secondary vacancy rate at 1.4 percent and 3.5 percent, although some low-quality buildings are struggling to find new tenants after being vacated by large government occupiers,” he says.
One recent trend he has noted is for tenants opting to exercise their renewal options instead of relocating within the CBD office sector due to limited new supply of quality office space coming on.
Moricz says the new Wellington supply pipeline is large but almost fully committed by mainly government occupiers. Following the completion of the 6400 square metre Chews Lane building for LTNZ in the first half of 2008, 99,000 square metres is forecast to be completed between late 2008 and the end of 2010. Only 6700 square metres of this is still seeking tenants. While most of the occupiers are relocating from existing Wellington CBD premises these tend to be of secondary quality and will only have limited impact on the prime vacancy rate, he says.

Tips for making deals
Brookfield Lawyers’ property partners Ian McCombe and Howard Johnston offer the following advice.

What are the key points to consider before making lease deal?

From tenant’s point of view – flexibility. Never take the landlord’s standard form at face value – always get legal advice.
From landlord’s point of view – strength of tenant is vital. At the point the landlord establishes that the tenant has good potential and that they want them to sign they will want to listen to what the tenant wants. They would rather negotiate with good prospective tenant than let the building stay empty.
This will, of course, depend on the landlord. Institutional landlords are well resourced and to some degree can insist on their terms being met, but private investors can’t afford to have buildings vacant for too long.
One of the biggest ov

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