Over the past several years institutional investors have taken advantage of cheap financing to buy commercial realty, counting on rental yield and capital growth to cover financing costs, which worked when rents were rising and vacancy was low. Now cheap financing has dried up, rents have dropped and vacancy rates have increased, leaving landlords struggling to achieve a positive return on investment. According to the The Economist (August 1, 2009), this is a global phenomenon. In Budapest vacancy rates have surged to 15 per cent; in Prague they have doubled to about 10 per cent; in Manhattan office space vacancy rates climbed to 11.2 per cent in the first half of 2009, while rents have dropped 16 per cent over the past year. Rents in Moscow have dropped by 63 per cent for the 12 month period ended June 2009. Singapore’s rents dropped by more than half between June 2008 and June 2009. Rental rates in Mumbai and Singapore are down 40 per cent and 32 per cent respectively.
In the U.S. commercial property prices dropped by 7.6 per cent in May 2009 alone, leaving them 35 per cent below their peak in October 2007.
Commercial realty economics in the GTA (Greater Toronto Area) is following the global trend. According to the Toronto Real Estate Board, the number of feet of space leased July 2009 compared to July 2008 declined by a staggering 70.8 per cent and commercial rents declined 19.8 per cent!
So why are existing tenants rents increasing?
Because sophisticated landlords will find ways to force existing tenants to cover their losses!
Landlords who bought realty a number of years ago are under significant pressure to extract increased rent from remaining tenants to achieve their investment objectives – despite the market conditions. And they are accomplishing their objectives by the following means:
Sophisticated landlords and leasing managers. The days when a simple negotiation, face to face, between a part time landlord and tenant are gone. Typical landlords are now using the services of well educated, professional leasing managers whose services are paid for through additional rent. These professionals will manipulate lease terms and conditions and use sharp negotiation strategies to accomplish their objectives.
Premises re-measurement. In many leases (likely including yours), landlord has the ability to change the area measurement criterion on which the rent calculation is based from time to time, resulting in a corresponding rent increase. Imagine your rent increasing 30 per cent because landlord re-interpreted the lease. It’s that simple!
“Padding” additional rent. Descriptions of additional rent inclusions and exclusions often permit “convenient interpretations” enabling landlord to include inappropriate costs. Carefully negotiated lists of permitted and excluded costs have limited value without tenants ability to review source documents and challenge items. Tenants share of the total additional rent cost for a development is often incorrectly administered by landlords with the net effect that in total, the collective tenant community pays more than 100 per cent of the costs. Even when a landlord is caught “padding” additional rent, expensive and time consuming litigation is often required to enforce the provision.
Charging for formerly free services. Leases which do not include a description of parking, storage, or signage facilities and charges are an open invitation for landlord to announce a new cost schedule. After all, what recourse would tenant have if, for example, parking charges increased by $1000 per month?
New lease. Lease forms common 10, 15 and 20 years ago were generally more tenant friendly and less complex than contemporary lease forms. Given significant pressure to increase rent, landlords will jump at any chance to impose a new lease which will likely cost tenant significant money. Missing a lease term renewal option expiration date is an invitation to enter into a new, expensive and less favourable lease form.
In this economic environment, you can be sure landlord is doing his homework. Make sure you do yours.
- Understand your lease, especially area measurement criterion, additional rent provisions, and term dates.
- Check every additional rent statement against lease terms.
- Check any rent increase against lease terms, especially increases related to premises re-measurement.
- Administer your renewal options properly. If you approach your landlord at the correct time prior to term expiry, you will have the leverage position required to adjust your rent to current market conditions.
Most importantly, level the playing field. Consult with or retain a professional who understands the current realty market and lease mechanisms.
Mr. Toms has been creating and preserving realty leasehold value for tenants and landlords since 1986 and can be reached at (705) 743-1220, by e-mail at iantoms@pipcom.com, or through his web site at: www.iantoms.com |