Industrial Lease Terms Plummet

INDIANAPOLIS-Average terms for industrial leases have fallen steeply since January. A new report from Grubb & Ellis reveals leases signed in the second quarter were the shortest of the decade at 43.4 months. The average at the end of 2008 was 50 months.

Grubb senior vice president and chief economist Bob Bach attributes the decline primarily to the fact the recession and weak corporate profits are prompting many tenants to choose short-term extensions as their leases expire instead of new five-year leases. “These tenants prefer the flexibility of a shorter commitment to the generous terms on offer by many landlords, who would prefer to lock in tenants for longer periods,” he says.

On the other hand, continues, not all landlords favor five-year terms under current conditions. “Some think three years is the optimum length because they believe that rental rates will begin to rebound before the five-year terms are up, and they want to be in a position to raise rents as soon as market conditions permit,” he explains.

Bach tells GlobeSt.com he thinks the precipitous decline that occurred in the first two quarters will level off soon, but he also believes the average lease term will stay low for the foreseeable future. “The reason it will level out is that it can only go so low,” he says. “The reason I expect it to remain low is that as long as labor market is losing jobs, which most economists think will be the case through the middle of next year, you won’t see pickup in leasing activity.”

Another factor in the decline, says Grubb senior vice president Tim Feemster, is that some tenants have signed very short-term deals with landlords in order to store excess inventory. “That typically happens when the downturn starts,” he explains. “With all the inbound production, they don’t turn the spigot off quite fast enough and end up with too much product.” But the inventory has largely been pushed through by this point, and few such deals are necessary now. The growing number of subleases also contributes to shortening terms, he adds, since most have less than the full lease term remaining.

According to Feemster, who is the company’s national director of global ogistics, transaction services, many landlords are attempting to hold out for five-year leases by offering two years at lower rent levels and a substantial jump in year three. Tenants, not surprisingly, are balking. “It’s one of these tug of wars: who’s going to blink first?” he says. On the other hand, tenants who feel their business is sound, especially big-box tenants, are willing to take on five and seven-year leases with significant bumps in two years, if the bump is reasonable. “They’re getting all kinds of incentives from landlords to cover a lot of concrete,” he tells GlobeSt.com.

The Grubb data shows a similarly steep decline in office leasing terms. While two- six-month leases for inventory storage play little role in the office picture, subleases and month-to-month extensions play a bigger role.