Landlord Strategies, Oppositional Landlords and Leverage: Random Thoughts

Rent, or net operating income, is 100% correlated with value.  When an owner lowers the rent, they reduce the value of their building.  This is why many investors will do all sorts of things before lowering rent.  For example, the most common approach is to provide big allowances and/or large amounts of free rent in exchange for rate preservation.  It doesn’t feel great, but since it protects asset value, it’s in chapter one of every institutional owner’s playbook. 
 
But not all owners have the same motivation, which is why we see so many different approaches to declining markets.  Investors who are committed to a long-term hold strategy are generally less concerned with rate preservation (they don’t plan to sell any time soon and may prefer to limit capital spending in favor of lower rents).  Most major markets will have a full spectrum of owner motivation profiles and strategies. 
 
At the end of the day, a proper, declining market strategy for the occupier (tenant) will include a broad sampling of these unique owner motivation profiles (e.g., not just institutional rate preservationists).  In negotiating with owners, all scenarios should be compared in a comprehensive model that captures total occupancy cost, which includes rent and all other spending.  While the rate may be more favorable in scenario A than B, scenario A may also come with a hefty capital requirement (a tenant cost); which, once fully vetted, may render scenario A more expensive than B from a total occupancy cost perspective.
 
Our TenantSee Weekly topics are usually a direct reflection upon real world events unfolding in our practice from one week to the next.  This week, as we think about the different way owners approach declining markets, we’re struck by the failed strategy of Oppositional Landlords (see our earlier writings on this subject in the content library at www.lowfogg.com).  These owners often define their negotiating strategy based on drivers that are misaligned with the market (e.g., the owner who refuses to pay a leasing commission).  The smart occupier, properly advised, will easily leverage this failed strategy by letting dialogue with the Oppositional Landlord die a fast death, instead focusing on identifying and negotiating relocation scenarios.  Should the existing space remain of interest in the context of a lease extension, the tenant may reengage with the Oppositional Landlord at the end of its process. This, of course, leaves the Oppositional Landlord with one move…to undercut the market.  Adding insult to injury, these landlords typically lack market data because their market posture isolates them from market participants (notably brokers).  They’re forced to compete by blindly lowering the value of their offering.  Not good.    
 
Leverage is present in every negotiation.  One of the keys to good negotiating is understanding leverage - - - importantly, both yours and theirs.  These are some strange times in office markets all over the world, but especially so here in San Francisco.  Stay focused and fear not the Oppositional Landlord!