Office concessions are increasing and are on track to mirror the significant concessions last seen in the Great Recession. Research from Trepp and Compstak found that the spread between starting rents and effective rents has increased 27% in major metro markets, including New York City, Los Angeles, San Francisco/Bay Area, Chicago, Boston, and Washington D.C. In the period following the Great Recession rent spreads increased by approximately 106% for three quarters and peaked 10 quarters following the market trough.
In terms of concessions, landlords' go-to tool has been free rent. Trepp's report uses a recent lease transaction at 28 Liberty Street in New York as an example. The landlord gave an insurance company six months of free rent on a 15-year re-trade lease negotiation. The same is happening in the sublease space. A new tenant at 900 3rd Street Ave. in New York received five months of free rent on a sublease transaction.
These examples are not anomalies. Since the start of 2020, there has been a 30% increase in the ratio of free rent. Today, free rent makes now makes up more than 5% of the total lease term. Again, this is a similar increase in free rent as was seen in the period of 2009 to 2011, following the Great Recession, and provides insight into the significance of this economic downturn.
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Concessions have been necessary to renew tenants with stability. However, there has been widespread destabilization in the office market with rent collection issues. Year-over-year, NOI has decreased by nearly 5%. By comparison, other property types excluding office have only seen an NOI decline of 3.7%. There is currently $3.3 billion in outstanding CMBS office debt across 245 properties that have requested forbearances.
Still, delinquencies and special servicing rates have remained low, particularly compared to other property types. There are still strong headwinds, though, including flexible workspaces and the potential for reduced office needs, that could have a negative impact on the market.
For the near-term, most office tenants have long-term leases. This could buy office owners some time to adjust and help them to meet their debt service lease obligations. Tenants with upcoming lease renewals, however, may choose to downsize or re-configure their current office needs. Ultimately, this will have an impact on office activity.
For both tenants and landlords, lease structures will need to change. Likely, both parties will want to address force majeure clauses, rent abatement and health and safety requirements, among other things, in new lease structures.
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Kelsi Maree Borland
