How Manhattan's Market Dynamics Can Lower Your Real Estate Costs

Commercial real estate markets typically lag the broader economy in recovering from a recession. This is good news for any business that leases space. Office vacancy rates remain high and landlords are cutting serious deals to lure new tenants and hang onto existing ones.

Just how favorable is the market for tenants? Asking rents have fallen steadily since the market’s peak in 2001. Throughout Manhattan’s primary office districts--Midtown, Midtown South and Downtown--average asking rents fell 7 percent between July 2002 and July 2003, according to the brokerage Cushman & Wakefield Inc. (www.cushwake.com).

But these numbers alone do not tell the full story. Discount packages, known as concessions, typically include several months of free rent--up to 24 months in some cases, depending on the term length and other considerations--and many landlords are paying for moving and renovation costs. Concessions such as these can substantially lower a tenant’s effective rental rate.

Property owners are able to offer bargain pricing because of record low interest rates that are allowing them to meet debt obligations despite smaller income streams. This is an important leverage point to keep in mind when negotiating with a landlord: the pro forma rate for many buildings, i.e., the minimum income that a property must earn to satisfy lenders, is below most effective rental rates.

“Due to present market conditions, nothing is impossible,” observed Ken Ruderman, executive managing director of Julien J. Studley Inc. (www.studley.com), a brokerage that represents only tenants. “If there was ever a time to implement a creative transaction and turn it into a reasonable idea, it is now.”

Lower Rents Without Leaving

Fortunately, your company does not need to move to take advantage of today’s favorable market dynamics. Lease renewals and restructurings, in fact, currently comprise more than 80 percent of overall leasing activity, according to Cushman & Wakefield.

“Your business has to dictate your space needs and if your business is promising and you’re a company that doesn’t look like it has any economic challenges, I would recommend signing a long-term lease based upon the current real estate rental rates and concession packages being offered by landlords,” said David Dusek, a director of the Manhattan-based firm.

But if your business is willing to move, certain districts in Manhattan are less expensive than others and you can use this to your advantage. For example, rental rates in Midtown South--which extends from 34th Street to 14th Street--are lower than the citywide average because the area’s building stock is older.

Below 14th Street, meanwhile, state and federal programs such as the Lower Manhattan Economic Revitalization Plan (www.downtownny.com) offer tax abatement and other financial inducements that can reduce a tenant’s effective rental rate even further. The most generous incentives are available for firms that locate in Downtown buildings constructed prior to 1975, or near the World Trade Center site.

Exploring your options in today’s market is well worth it. Real estate is typically the second or third largest expense on a company’s income statement. Particularly for small- to mid-sized firms, reducing occupancy costs is an excellent way to free up much needed capital for business development.

Steps to a Rent Decrease

Retain a broker to review the language of your lease for leverage points. You might be qualified to do this yourself, but do you really have the time? A broker does. Many landlords, moreover, will pay your broker’s fee.

“Leases can be anywhere from a couple of pages to a couple of inches thick and most people open them only when they need to. A real estate professional should know every page of a tenant’s lease. Clauses in the lease can be uncovered--renewal options, extension options, even termination options--and can be used on behalf of the tenant even though they had no intention of using them,” Ruderman said.

Brokers also bring intimate market knowledge to the negotiating table. For example, do you know how much rent the other tenants in your building are paying? Does another tenant have its eye on your space for an expansion of its own offices? A broker will know the answers to these questions and, more important, a broker will know how to use the information as leverage.

Play one landlord against another. If your company has a good financial track record, or if it is growing by leaps and bounds, you might be able to convince another landlord to offer you a better deal elsewhere and buyout your existing lease. The threat of this might be enough to convince your current landlord to offer you an even a better deal, Ruderman said.

A New Sublease on Life

Consider sublease space. This option makes sense if your firm is a startup, has less than stellar credit or faces a fluctuating headcount. A sublandlord--a tenant that holds the master lease but no longer needs its space--will slash rental rates far more generously than a direct property owner. The shorter the term, the deeper the discount.

“Larger institutions will be more flexible because they’ve got a huge amount of sublease space on their books and they’re

prepared to take huge write downs just to move it,” observed Hank Walker, a vice president of CB Richard Ellis Inc. (www.cbrichardellis.com), which is the largest property brokerage in the world following its recent acquisition of Insignia/ESG Inc.