The Future Isn’t What it Used to Be
Ian D. Toms

The economy is very different than imagined or predicted even two years ago, and we all need to shift our field of vision to adjust to the new reality. The party is over, and a big hangover has set in. No aspirin will cure this one – and it’s not going to go away any time soon. So what’s in the forecast for commercial tenants?

Consider the current realty leasing market. As we now know, the free spending habits of times past are over and won’t return anytime soon due to increased unemployment and high personal debt. Interest rates are expected to increase, squeezing the already pinched consumer even further. Reduced consumer spending means reduced sales and reduced ability for tenants to pay rent. When tenants aren’t able to pay their rent, less space is leased. The Toronto Real Estate Board reported that 5,829,559 square feet of space was leased in 2009, down 51 per cent from the 11,961,934 square feet leased in 2008. Tenants failed, or did not renew their lease terms and closed.

Decreased demand for space has put pressure on landlords to maintain profitability by aggressively looking for rent. Surviving tenants are being squeezed to the maximum extent permitted by their leases, and then some! In this context, neither landlords nor tenants are rubbing their hands with glee. As the saying goes, when the water hole dries up, the animals start looking at each other.

The Forecast

For the next few years, the leasing weather will be unsettled, with primarily cool and overcast conditions. Look for occasional sunny breaks. Beware of two major storm systems approaching.

The first storm will arrive July 1, 2010 when rent will be subject to HST, which will have the net effect of increasing rent by eight per cent. That’s $320 per month, or $4339.20 per year on rent of $4000 per month. The second storm will gradually creep into our area over a period of several months if not years. As interest rates increase, consumer spending will decrease further. At the same time, rental rates will have to increase to offset higher mortgage payments by landlords. But tenants will also face higher financing costs. An already aggravated situation will become critical.

Look for additional rent to increase as pressure builds on landlords to improve profitability without the ability to charge more base rent. Tenants need to audit their additional rent statements carefully. You can bet the landlord will be! Landlords will look closely at leases to make sure they are collecting all possible rent. I am watching landlords announce lease audits and collecting “forgotten” rent charges retroactively. Space is being remeasured to increase rentable area and therefore rent.

Landlords will also be looking at lease terms and conditions very carefully collecting all information available to design and improve their negotiating position. Woe to tenants in older buildings with demolition/early termination clauses in their leases as landlords demolish and redevelop their properties instead of investing in new plaza development in the green and growing areas.

Look Forward To And Prepare For Occasional Sunny Breaks.

• Expect base rental rates to remain at about the same levels as they have been for the past number of years. If your base rental rate remains the same for 10 years, then compared to an average annual inflation rate of two per cent the base rate actually drops by 20 per cent over the 10 year period.
• With more space available to lease, consider relocating to your dream market or location. As vacancies open up, that perfect unit may become available.
• Developers are shifting their focus to renovation or redevelopment of existing properties in urban areas. Perhaps your building will receive a facelift, or you could move to new and exciting space built in your area where no new space has been available for years.
• Landlords will become more “flexible” negotiating renewals as tenant favourable leverage positions improve because tenants now have the ability to relocate which they didn’t in the past.

Finally, consider buying your own property, even a plaza. I’m seeing “realistic” sale prices now as the shine wears off properties which were traded beyond their value a few short years ago. I expect to see distress sales to become more frequent as interest rates increase.

My advice? Make the best of the weather. Actively manage both your location and your lease obligations based on practical, objective and realistic expectations.