Landlord vs Tenant Expectations

The Expectation Gap Between Landlords And Tenants

 

In response to the “COVID Recession” Tenants expect that when they go to lease office space, they are going to get a better deal than they would have in February.  Yet, Landlords have a sunny outlook and are offering “no COVID discounts!” How can Landlord and Tenant expectations be so different?

 

The Tenant’s Perspective

Most businesses are suffering economically in some way, as a result of COVID 19.  Very few Tenants in Toronto are currently occupying their office space, and if they are, it is at a dramatically reduced capacity.  

In Cresa’s advisory practice, we see corporate clients planning “back to the office” strategies. Most anticipate going back after Labor Day in phases: such as, Phase 1 at 10-20% capacity and Phase 2 at 30-40% -- Phase 3 is a question mark for now. As workers return, there will be protocols for social distancing, unidirectional traffic flow and sanitization processes. 

Tenants don’t have a plan for a “back to the way things were” scenario.

This is not only because of health factors and expectations that the pandemic will be with us for a while. There is a newfound recognition that many employees can work effectively from home and they want to! This is a win-win scenario where workers value the flexibility and lifestyle benefits of work from home and management can envision reducing real estate and general office costs going forward.

This is not to say that we won’t need physical offices, since many workers don’t have ideal home conditions and because they value the social interaction, mentoring and synergies that come from being in the office.  But there is definitely an opportunity for both home and in-office workstyles.

Tenants are at a pivotal point where there is downward pressure on the demand for office space and the world as we know it is irrevocably changed! The initial data supports this trend – in Q2 versus Q1 the Vacancy and Availability of space have reversed the trend from declining to increasing (Downtown 2.9% to 3.6% vacant and 5.4% to 6.4% available*) . 

If a typical Tenant’s lease was up for expiry would they renew as is?  Likely not!

In fact many Tenants are already shedding space as Sublet listings and availability have skyrocketed in Q2 (approximately 600,000 SF of sublet space added in the Downtown core since Q1) *

 

The Landlord’s Perspective

Before the March shutdowns, vacancy in downtown Toronto and throughout the GTA was (and remains), at an all-time low (2.9% in Q1).  Rental rates are at all-time highs at $34.84 Net Downtown and $19.52 across the GTA.  Although rates have declined slightly and vacancy increased slightly, many buildings have long term leases in place. Landlords want to believe that this is going to go on forever. In fact many Landlords believe that Tenants will want to take more space so they can “social distance” their staff. 

We haven’t seen any Tenants say they want to expand.  Quite the opposite, Tenants plea that they need price reductions to make sense of the deals that are being presented to them.

In short, Landlords are doing what they probably should, given the occupancy levels that currently exist.

 

Where is the market going?

How is all this going to play out is anybody’s guess. However, if you subscribe to the view that our world is irrevocably changed and there will be some level of continued reduction in demand, vacancy will increase, and prices will need to change. 

 

So, what’s a Tenant to do?

·Be realistic- Rental rates are likely going to be higher than you’d expect, and Landlords will be less flexible. Timing markets is always difficult; if you need to renew a lease or relocate you likely need to take some action. Consider going short term until the future is clearer or the market softens.

 

·Be flexible and creative- There may be better deals in other neighborhoods and in specific buildings where vacancy is higher. We already see those Landlords being more flexible. Stay away from bully Landlords who won’t acknowledge what’s going on in the world. 

 

·Be patient- If you are not up against an expiry then wait for the market to open up. You can bide your time to let things play out while you start planning for what your new footprint might look like and you evolve your work from home strategy.

 

·Consider reducing footprint- Taking less space or subletting parts of your existing space can help to keep your costs lower if you do subscribe to a partial work from home strategy.

 

·Shop the sublet market- With the surge of new sublet space hitting the market,  it is likely that prices will decline on sublets before they do on “direct with Landlord” space.  Although even in this instance, this may take some time.

 

·Have multiple options- Lastly, remember that there are always options and having an objective view of your best alternatives will put the negotiating power on your side.

 

*Market data provided by CoStar

 

 

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