What is Going on With the Office and Industrial Markets?

Commercial Real Estate (CRE) defaults are on the rise, with 42 markets across the country seeing an increase in CRE distress. This represents a whopping 84% of the nation’s 50 largest metropolitan areas. So, a huge scope of the country’s CMBS loans are in trouble.

What does this rocky environment mean for landlords? Well, don’t take it from us, listen to Warren Buffett’s recent assessment of what the dismal future has in store…

But that doesn’t mean that the heat is only on landlords. Currently, both the industrial and office markets are suffering. But the way in which they’re suffering tells a different story, and has different implications across the class type and tenants.

Read about the slowdown in the industrial and office markets, what it means for property owners and tenants alike.

The Dip in Industrial Demand 

The industrial market has been playing a game of cat and mouse, with supply and demand out of sync.

The pandemic initiated an almost immediate shift in the consumer’s preferred shopping means from in-person to online retailers. Industrial space became an instant and red-hot commodity as powerhouses like Amazon rushed to scoop up and expand their industrial footprint. They couldn’t build warehouses fast enough. And this was shown in the steady and significant growth of warehouse asking rents.

But developers also rushed to capitalize on the demand for warehouse space and profit off the inevitable strain on supply. Now shockingly, with millions of square feet under construction or newly released to market, the industrial sector is becoming oversaturated.

Since then, companies like Amazon have closed multiple industrial facilities or subleased out industrial space it turned out they no longer needs or doesn’t make sense financially. Despite this, rent price tags continue to grow. This is in part due to the premium and updated features that tenants demand in warehouses that support fast shipping and efficient energy use.

Now an increasingly oversaturated market is driving the vacancy rate back up, which is expected to continue through 2023. But this is good news for prospective warehouse tenants though. The rent growth is expected to dramatically cool done in relation to the increased supply.

But despite a predicted dip in rent prices, the overall market still shows consistent promise (far from what’s going on with the office sector, experiencing an existential crisis). Occupancy rates remain strong, and the field has seen gains well above the pre-pandemic environment.

So industrial tenants can rest easy and maybe even benefit from a swing into the tenant-favored territory. Learn how to maximize the value for your tenancy if you are searching for warehouse space. 

The Office Market

The slowdown in the office market is for very different reasons and has far different implications for tenants. The oversupply has reached record levels. 

Despite the almost cataclysmic drop in office demand, vacancy, and occupancy rates, looking at the asking rents tells a different story, concealing an even more dismal outlook for office landlords and tenants. There is currently an environment in which rents asking rents appear deceptively high, or in this case, relatively normal- at least for pre-pandemic America. Despite landlords doing their best to remain consistent in their base rent price tags, the average costs per tenant have been driven up significantly.

Because while tenants may agree to a certain initial price for base rent, they’re saving drastic sums of money elsewhere, often in concessions. Landlords have been obligated to offer businesses more generous concession packages including hefty TI allowances, longer periods of rent abatement, or less frequent/ expensive escalations.

To lure in commercial tenants in the age of remote work, landlords have to make the deal worthwhile. And this takes measures they normally wouldn’t concede to like covering soft costs in renovations and basing rent on occupancy rates. So, all this culminates that landlords are losing money. And according to GlobeST, “Delinquency rates are on the risk, from 1.6% at the end of 2022 to 2.9% at the end of the first quarter of 2023.” 

This triggers new trouble on the horizon, an environment where an increasing number of landlords can’t pay the bills.

A crisis reminiscent of 2008 becomes a possible reality banks are poised to take over failing leases. 

And the ugly truth of it or tenants is that if the bank takes over your lease, there’s probably little you can do in the aftermath. You may be looking at a decline or drop in services entirely.

Tenants Should Get Smart 

That’s why if you’re looking for new space, you need to implement precautionary safeguards in your lease before disaster strikes. These terms retain some of your rights and financial protections should your landlord come under hard times.

If your landlord (or the new owner) does not maintain sufficient maintenance and upkeep, you can negotiate for “The Right of Offset.” This term will empower them to upkeep essential services at the and deduct out-of-pocket costs from the rent.

And this could really apply to anyone is more likely than you think if the building is in receivership. Because, once the building is in receivership, the receiver’s first responsibility is to pay the mortgage. All other bills are secondary. Therefore, you can almost certainly expect a drop in services.

Without this, you have no legal leg to stand on to deduct such expenses from the lease. So, you may end up paying for additional office cleaning even though you still have to pay your full rent. 

Other options tenants include putting their tenant improvement allowances in a credit letter or escrow. This will ensure that you don’t lose any renovation dollars the landlord promised to reimburse. This is especially important because they were making such big promises.

Another powerful safeguard to make certain is in your lease is a a subordination non-disturbance, and attornment agreement (SNDA). These allow the tenant to keep occupying the property according to the existing lease terms, even if the landlord loses ownership.

There is so much at stake for tenants right now navigating a minefield of defaulting landlords. That’s why businesses in this new environment need to do their due diligence identifying the state of their landlord's finances. This, of course, requires doing your due diligence and conducting research on their current and projected stability. Because all in all, working with landlords who have stronger financial backings will increase lower your risk. But, there's so much more at stake for tenants. And that is exactly why a tenant representative is all the more important. 

True Tenant Reps™ to the Rescue 

In this environment, commercial tenants need to protect themselves and navigate the uncertainties of the market. In the face of increasing defaults and financial challenges, partnering with a True Tenant Rep™ becomes a critical step for commercial tenants. Their knowledge, experience, and negotiation skills provide tenants with a strong advantage in lease negotiations and safeguarding their interests. By leveraging the expertise of True Tenant Reps™, tenants can navigate the complexities of the current commercial real estate landscape and secure the best possible outcomes for their businesses. 

Read more about what tenants can do to protect themselves. 

4 Ways Commercial Tenants can Protect Themselves From the Office Apocalypse.

Learn the steps True Tenant Reps take to protect tenants' portfolios in a recession: 

Prepare Your CRE for the Recession with the Three R's