Raising the bar to hold onto office tenants
Deals offered to stay in current offices are now as enticing as those luring them away
Landlords have long offered deals to businesses to encourage them to extend their office leases.
But now such deals are being matched by landlords trying to keep tenants from being lured elsewhere. It is a phenomenon previously unheard of, experts say, with rent-free periods topping the list.
“Before COVID-19, landlords knew that moving was an inconvenience and that companies were invested in a building because they had paid for a fit-out, so incentives to stay were always lower,” says Michael Greene, head of tenant representation - Australia, JLL. “But now the bar has been raised.”
Office markets are becoming more active than before the pandemic as businesses search for space better suited to their post-pandemic requirements. In turn, office vacancies are elevated in some markets, with landlords potentially facing more downtime between tenants.
“In response, existing landlords are more likely to meet the market in terms of incentives,” Greene says.
Offers on the table
Over the past 24 months in Sydney’s central business district, for example, the value of incentives has increased from an average of 21 percent to 34 percent, according to JLL Research data.
Incentives on offer from landlords include capital contributions to upgrade fit-outs, rent free periods, rent abatements or a combination of all three.
“When COVID-19 emerged in early 2020 and organisations started consolidating and handing back space as a result of the economic impact caused by this pandemic, we saw a sharp rise in incentives as vacancy rates increased, to varying degrees, across Australian office markets,” says Paul Chapko, director of office research – Australia, JLL. “Landlords were offering higher incentives to retain tenants or secure new leases in their assets. We noted instances where landlords were offering delayed commencements or additional costs to fund a fit-out for a tenant on top of the headline incentive figure during the peak of the pandemic.”
Additional incentives are on offer in the form of delayed lease commencements - a form of additional rent-free outside of the lease term - increased allowances to upgrade floors and early break rights.
“Building upgrades are also high on the agenda for landlords hoping to retain tenants and keep occupancy levels stable,” Greene says. “COVID has accelerated the need for greater flexibility for tenants. In some buildings this is access to flex space for projects or training, allowing for a commitment to a smaller amount of ‘core’ space. In other cases, the tenant has sought enhanced expansion and contraction rights to deal with unexpected events.”
To stay or go?
While incentives may be enticing, they are just one element to be considered for businesses deciding to move.
“If a tenant is happy with its building, fit-out and location, then staying put is a real option,” says Greene. “But for those that need to use their space differently and are trying to change the image of their business or have a commitment to being carbon neutral by a certain date and are currently leasing a 40-year-old building, that change will be easier to make in a completely new space.”
While the current incentive trend is unprecedented, it may also be peaking.
In Australia, Q4 2021 saw the national CBD office vacancy rate fall for the first time since Q3 2019 with a contraction of 0.4 percentage points to 13.7 percent according to JLL data. It should be noted that national CBD vacancy remains well above the 10-year long-term trend of 11.2 percent and is projected to remain elevated over the next year as new office assets complete and backfill vacancy becomes available from tenants relocating into these new assets.
In the last six months of 2021, the demand recovery was slowly gaining momentum with Australia’s CBD office markets recording 133,000sqm of demand over Q3 2021 and Q4 2021 compared to -48,700sqm of demand over Q1 2021 and Q2 2021. Whilst there are potential headwinds that could stunt the demand recovery such as the recent Omicron variant COVID-19 outbreak across Australia, organisations seem to be looking through this short-term volatility and continuing to do deals.
“The market’s certainly been turned on its head, but tenants will be feeling fine,” Greene says. “They should make the most of every opportunity.”