REMA Executive Forum:
Dealing with the Tenants' Market

Craig Bjorklund
Director ofProperty Management
Opus North Corp.

Bob Chapman
Duke Realty Corp.

Arvid Povilaitis
Equity Office Properties Trust

Harlan Stanley
Managing Director
LaSalle Investment Management

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One of theremarkable things about a free-market economy is that no matter howdifficult things are, someone is doing well. In office marketsacross the Midwest, that someone turns out to be tenants,creditworthy tenants, especially, but as a whole it's a fine timeto be out shopping for space, or to be across the negotiating tablewith your current building owner.

Those owners are doing whateverpossible to retain those tenants or attract new ones. A lot dependson what kind and how many buildings a company is responsible fortaking to market, but there are common themes. For the firstReal Estate MID-AMERICA Executive Forum, editor DeesStribling spoke with four representatives of office ownership thatdo major office lease deals in the Midwest. Angela Gentry providededitorial assistance.

REMA: It's a toughtime for office owners and leasing agents. What are some of thestrategies that you are pursuing to retain tenants?

Arvid Povilaitis: Interms of retaining tenants, some of the things that we've donerecently in terms of our organizational structure were done as alonger-term strategy. We're creating service centers that bring allof our management and leasing folks together. It creates anenvironment of enhanced customer service, accounting, managementand property leasing and delivers those services to each of ourbuildings from a central location.

The service platform is structured to allow the managers more timeto spend with customers, to understand their needs and make surethat services are being delivered. We've created functional groupsthat have experts in various areas to focus fully on their tasks,so our people servicing customers or dealing with contractors havemore time to dedicate to them.

HarlanStanley: It's tough leasing right now, so obviously if youcan retain a tenant you're saving a lot of money. One thing we canoffer a current tenant that other buildings can't is adjustment intheir current rent, and to the extent that we can use that as aneconomic advantage to retain tenants, we're trying to do that. Whenthe markets are more tilted toward owners, you wait longer to tryto address renewal tenants, but now we're trying to be aggressiveabout that and address the situation early--as much as two years.Unfortunately, tenants are making more requests, but that's notsurprising. Everyone knows that the operating environment is weakand that there's an opportunity for tenants to take advantage ofthat. They are asking for rent abatements, concessions andimprovement allowances. We won't do absolutely anything, but ourjob is to try to accommodate the tenants. For instance, we'regiving them more expansion rights than they had before and in somecases the ability to cancel out of leases if they want acancellation clause.

BobChapman: Retaining tenants begins before they move in. Wehave what we call a complete customer satisfaction program in whichthe process starts long before a tenant actually moves in, and it'sa 10-step process getting a tenant moved in, and making surethey're happy after that. If you wait for the broker to call youthe day these guys are thinking about renewing, it's too late. Youhave to know long before that what the specific customer needs andwants. Our property management people, and our maintenance people,meet tenants on a regular basis, and regional people like me alsomeet key clients regularly.

CraigBjorklund: We pretty much buy our own product. So we'rebuying almost all new office buildings that are fully leased up.Our primary strategy to retain these tenants is to have personalrelationships with them. That means making sure that the managersof the property, the tenant service coordinators, security andengineers actually get to know the tenants and their employees. Italso means that management has day-to-day contact with thedecision-makers and that meetings occur on a somewhat regularbasis, and that the tenants feel comfortable calling our people tolet us know what they need.

Once thetenants feel like they know you and you care about them, there's amuch stronger chance of retaining them. It's a matter ofresponsiveness and follow-up. It's the engineers knowing how to getthings done and getting back to people ready to help them out.Tenants have come to us from buildings where they never saw amanager.

REMA: What aboutretention strategies? Is there any end in sight for the tenants'market?

Bjorklund: Opusrelies primarily on outside brokers to do our leasing for us. Ourprimary attraction is that our properties are in pretty goodlocations and that's why they were so successfully leased up thefirst time. That still holds true for every property in my officeportfolio. Also, we've kept them up so that they still look newrelative to the marketplace. We haven't employed a strategy ofcompeting for every deal on an economic basis. We work a littleharder to attract tenants based on the quality of the product andlocation, verses being the cheapest product on themarket.

Chapman: We like tobe the dominant player in particular submarkets. So we identify ina particular city which two or three submarkets where we'll haveour business emphasis. Chicago is a little bit tougher since it'sso big, but if you get into the secondary cities like Columbus orSt. Louis or Nashville, in the two or three submarkets we choose,we will have a market share of 15% to 25%.

Povilaitis: In termsof attracting new tenants, it's critical to be a dealmaker and letthe brokerage community know by your actions that you're adealmaker who aggressively pursues deals. Continuing to partnerwith brokers is also important as is pricing aggressively. We lookat the platform of services we have and price them in a way thatmakes our properties attractive for tenants.

Stanley: One way of courseis just marketing-getting our material out and trying to identifyprospects. We're trying to be more aggressive about that, and we'realso doing more cold-calling than in the past. In some cases we'reoffering incentives to brokers in order to attract deals,especially incentives that brokers don't necessarily have to sharewith their house.

REMA: Is subleasing still the factor in the marketthat it has been in recent years or is it diminishing?

Stanley: It's less afactor than it was, but there's no question that it's still there.Some of it was short-term, and that burns off. But the overallconcern remains. The problem with sublease space is that the userdoesn't have the same economic objectives as the owner, so they canoffer rents that are substantially less than what you would bewilling to do.

Povilaitis: Subleasespace is still a factor, but it has diminished. We have hadsublease space in the Chicago MSA probably drop from 4% of thespace, or 5% depending on the statistics, to 3% or 4%. People arestarting to come out of their offices with plans for growth in thenext couple years. The second-tier markets outside of Chicago are alittle bit slower to act on the uptick in the economy. But they'realso markets that over time have been relatively more stable andhaven't had the decline that Chicago has had.

Bjorklund: Subleasingis certainly still a significant factor, even though the level ofleasing activity has picked up from a year ago. But activity isstill slow, certainly in the suburban Chicago market and Milwaukee,where a lot of that space is still sitting there. But time isrunning down on some of the subleases, and as the term gets lowerit becomes less of a factor, and you're almost looking at it moreas direct space.

Chapman: If you look at the numbers, the absolutevolume of sublease space is declining, but it's still out there.It's still a factor. If in a particular submarket, 10% or 15% ofthe space is sublease, that make it a factor. If it's 5% or less,it probably isn't. Regardless of the numbers, sublease is only afactor if it drags down rents. Most of the time sublease spacedoesn't enter the equation because there are so many constraints onit, be that office space configuration or the required tenantimprovement or the length of the term.

REMA: How are youcontaining operating and other costs?

Stanley: We're doinga number of different things. We're more religiously bidding outour service contracts. As you look at the operating costs, most ofthose are covered by different service agreements, so we arebidding those out to try to control costs. The bidding process is awonderful way of making sure that you're paying market andmaintaining your competitive edge. The other thing that we'redoing-and others are doing it too, like Equity Office-is leveragingoff our base of operations. It's large enough that we think we getsome leverage on both a national and regional basis. Not all ownerscan do it, but those who can do it should do that, and we certainlyare.

Povilaitis: In the beginning of this year, we re-bidour janitorial, security, elevator, landscaping, waste-hauling, andpaper-purchase contracts across the country, and we're in theprocess of re-bidding pest-control, water-treatment,HVAC-maintenance and window washing. As a result, we're expectingsavings anywhere from $75 to $100 million in 2004.

Bjorklund: We have one tax consultant that works forthe whole Opus North portfolio. When a building comes online, younever know what the taxes are going to be, but we do stay on top ofit and so have done a good job of containing our real estate taxes.Some of our properties have secured or partial abatements early on.As far as basic operating expenses, we do similar things othercompanies do. We do competitively bid. However, it's not a matterof being the lowest price but having a competitive price and goodservice.

Chapman: We'reconstantly fighting assessors on property taxes as well. We alsohave some national initiatives to take advantage of our buyingpower. We're constantly trying to renegotiate with utilities to getvolume purchases, since that's where the big dollars are. On theother contractual items like cleaning, we try to get economies ofscale too.

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