Tenants Continue To Rule The Market

Confirmation of Slowed Job Growth Likely to Keep Landlords Aggressive on Lease Deals

This week’s disappointing job growth numbers make it abundantly clear that it’s still a tenants’ market out there and no amount of aspiring to the contrary will make it easier for landlords fighting to attract and retain them.

The job news “is an obstacle and a cautionary line creating uncertainty in the short-term outlook,” said Carl Conceller, principal of NAI Desco in St. Louis, MO. “Landlords are keenly aware of the limited tenants in the market place and the need to maintain occupancy in a highly competitive market. Landlords will continue to be aggressive in structuring leases to capture tenants as early as possible, while blocking them from the competition.”

For the record, here’s a summary of monthly jobs number released this past week by the U.S. Department of Labor: Total nonfarm payroll employment grew by just 69,000 jobs; following 77,000 new jobs in April. By comparison, the average monthly employment gain in the first quarter of the year was 226,000.

In May, employment rose in health care, transportation and warehousing, and wholesale trade -basically the industrial sector. While construction, accounting and bookkeeping services, in services to buildings and dwellings and professional and business services lost jobs – basically the office sector.

“The report was disappointing, but not unexpected considering the negative economic news of late regarding the European debt and its potential impact on the U.S. economy,” Conceller said. “The report, in conjunction with the European debt crisis, has obviously disrupted markets and caused uncertainty among U.S. businesses.”

Larry Hausman, senior associate of Marcus & Millichap in Louisville, KY, said that if landlords were smart they would make whatever deals they can get done and still make a profit.

The job numbers don’t make prospects for the investment market very attractive either, Hausman said.

“Investors are going to shove their hands even deeper into their pockets, choosing to take their licks against inflation while staying in cash a while longer,” he said. “There will be fewer buyers until Europe stabilizes and more than 125,000 new jobs are created each month (what is needed to break even after population growth).”

NAI Desco’s Conceller had a different take on impact of the disappointing job numbers on investing.

“Investors recognize that the markets are at historic lows. The current environment provides unique opportunities to acquire investment properties well below replacement value with significant upside growth and returns far greater than can be achieved in alternate investments,” Conceller said.

“A major contributing factor to the investment market is the unusually low interest rates available to qualified investors,” he added. “Additionally, foreign investors are reallocating capital into the US real estate market because of the relative stability of the U.S. economy when compared to many foreign markets, the aforementioned report notwithstanding.”

Still, the latest job growth numbers proved to be a double whammy with little new hiring and more announced reductions. In May, the nation’s employers announced plans to cut 61,887 workers from their payrolls, the most since last September 2011, according to the latest job-cut report also released this past week by global outplacement firm Challenger, Gray & Christmas Inc. The May job-cut total was up 53% from April and 67% over May a year ago.

May job cuts were dominated by the computer industry, propelled by Hewlett-Packards announced layoffs of 27,000 workers.

“We may see more job cuts from the computer sector in the months ahead. While consumers and businesses are spending more on technology, the spending appears to favor a handful of companies. Those that are struggling to keep up with the rapidly changing trends and consumer tastes are shuffling workers to new projects or laying them off altogether,” said John A. Challenger, CEO of Challenger, Gray & Christmas.

Mark H. Fowler, senior vice president of Weichert Commercial Brokerage Inc. in Edison, NJ, said: “The market has definitely slowed down again. Smaller tenants were showing signs of entering the market, which we had not seen for a long time. However, that began to dry up well before last Friday’s numbers.”

“We are still seeing activity from medium to large tenant requirements but the bread-and-butter transactions are lacking,” Fowler said. “I am not sure that demand will worsen as a result of the numbers but we probably face a long, slow summer.”

“As for landlords, they have been itching to raise rents but this will only delay that process a while longer, as the advantage remains in the tenant’s hands,” Fowler said.

We polled other commercial real estate industry executives to get their perspective on the jobs market. The following is a summary of some of those comments.

Bottom Doesn’t Mean We’ve Turned Around

With a vast majority of our commercial appraisal assignments currently involving foreclosures, REOs and bankruptcies, this recent jobs report is no surprise. Even healthy Class A/B office tenants are looking to cut costs, and some are also downsizing office space. Leases that were signed back in 2002 and 2007 are coming up for renewal at “market rental rates,” which means the rates going-forward are going to be flat or below the original lease rates.

The Great Recession’s negative impact on tenant demand for Class A/B office space in this market appeared to bottom out approximately a year ago. Currently, the demand curve is still at the bottom of the cycle and favors tenants and investors seeking bargains.

However, the local market has too many Class A/B office properties in the foreclosure-bankruptcy-REO cycle which need to work their way through the courts and find their way back to new investors. As they go through the legal channels, these financially-distressed buildings generally are not properly maintained, which frustrates current tenants and makes the properties unattractive to prospective tenants.

New tenants are being offered generous TI [tenant improvements], free rent and very low lease rates, especially in suburban Class B office complexes. As previously mentioned, even healthy, renewing tenants are looking for better rates and terms.
John Irby, Appraiser, Pinel & Carpenter, Orlando, FL

Definitely Probably

I have to think landlords have been anticipating this, swinging the needle more to the lessee. That shouldn’t change in terms of concessions, etc. I think domestic and euro investors will still flock to CRE assets given the risk adjusted returns, risk premium (spread to cap rate over the 10 year Treasury) at all-time highs, even for core/core plus assets. This is also in the face of a lack of supply. And… QE3 [a third round of Federal Reserve quantitative easing] is definitely probably on the table now… We will see!
Coley O’Brien, CMBS Research, MKP Capital Management LLC, New York, NY

It Could Be Worse

The latest job numbers are an aberration, but numbers will continue to be week for six to eight weeks. The impact will be minimal unless consumer confidence takes a hit for a significant (eight to ten weeks) period of time. If things worsen longer term, tightening of concessions and rent could reverse course.
Ryan Phillips, President, Signature Asset Management Inc., Dallas, TX

We saw a significant upturn in demand for space in the fourth quarter of 2011 and in the first quarter of 2012, and took advantage of the upturn. We had enough stabilization the past 18 months or so in both occupancy and price that would cause us to remain consistent with our lease negotiations and pricing. The last two months has seen demand slow in each of the markets we serve. It’s disappointing, but not surprising. Due to the upcoming elections and specific policy-related uncertainties, I would expect the trend to continue at a stagnant pace.
Robert G. McDonnell, Senior Vice President, Ciminelli Real Estate Corp., Williamsville, NY

With interest rates at near historic lows, strong operators/investors should be able to reduce their debt service cost. This reduction can then afford the investors the ability to manage occupancy levels and rental rate concessions.
James M. Gottstine, Senior Vice President, Ciminelli Real Estate Corp., Williamsville, NY

Expectations Too High and Press Too Bad

The report is not a surprise. There have been no fundamental changes in the economy that would spur sustained job growth. The only positive development has been the reduction in oil (gas) prices. Landlords will not be impacted by this jobs report. They have been reacting to the poor economy and higher vacancy rates for years now, their behavior is established. Local and regional tenants are more impacted by positive or negative sentiment. “Bad press” can reduce confidence among these tenants, which will make them more tentative to sign new lease commitments. Larger national tenants make decisions based upon a more macro view and will not significantly change course.
David M. Barker, Broker / Owner, Acuity Commercial Group, Louisville, KY

The job report is not surprising. The positive side is that overall we are adding jobs despite the public sector losses. The disappointment comes in reference to the expectations. I am not sure where the expectations come from, but perhaps that is the problem… the expectations are too high.
Gary Goss, Senior Vice President, Cassidy Turley, San Diego, CA

Don’t Believe Everything You Read

The numbers don’t surprise me. I don’t trust the government numbers as the ways in which they track them are usually twisted in a positive way. Any negative news can stifle the confidence that has been building. There is a debate about the relevance of retail numbers regardless. I’d like to see more production numbers, both employment and output. The effect of unemployment isn’t felt as quickly or badly as higher gas prices, rising interest rates, etc.
Russell J. Bardolf, Director of Sales, Rock Commercial Real Estate LLC, York, PA

I earned a great living in commercial for 25 years and now we are fighting to make a 1,000-square-foot office deal at 75 cents per square foot!!! Gross. I don’t trust the numbers the government gives. I think it is worse. In more than 30 years in the business this is the worst I have seen it.
Richard Dick Myers, Great Estate Realty, Roseville, CA

I think their numbers are off ~ seriously. All we’re seeing from a tenant rep’s view are growth and expansion!
Debra Lee Stevens, CCIM, Principal, The Stevens Group | ITRAGlobal, Boston, MA

There are too many different reports on the economy, jobs, markets, and consumer sentiment. No one really feels tethered by these mixed reports. Government is trying too hard to read “Good News” into everything and not letting the market and businesses/consumers work thru these issues with normal maturation and normal demise.
Ron Deem, Commercial Sales & Leasing, Long & Foster Commercial, Mitchellville, MD

Most investors have known for a long time that the government has been skewing the numbers to make a horrendous situation look better. You cannot put earrings on this pig, without the pig showing up some day. If this is the new numbers with the best lipstick available, it is much much worse. My clients hunkered down for this storm years ago. We are on the front lines, not in the bubble of Washington, DC, or the Casino of Wall Street. We will survive at a different level. At the end of the day real estate is still there (more than I can say for derivatives). (credit to,m, heschmeyer, co-star)


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