Favorable rates and terms for landlords looking to backfill vacant spaces could be a thing of the past, at least temporarily, according to a new analysis from commercial real estate data provider Trepp, GlobeSt.com reports. The combination of falling rental rates and increased “going in” cap rates have sped up the decline of property value. Meanwhile, cap rates have increased because of the high risks that come with an unstable asset.
“For some operators who acquired their assets between 2010 and 2011 and pre-covid 2020, they have always been able to backfill their vacant spaces at rental rates and terms that are more and more favorable to the operator,” Trepp’s Lonnie Hendry wrote in his analysis. “Those days are over, at least in the short term, and more than likely, the medium to long term as well.
“The recent market disruption has caused unprecedented sublease space availability which immediately reduces market rental rates in those markets. Tenants with existing leases that are set to expire are not going to renew at their current contract rental rates. They are going to demand the sublease rental rate, or in most cases even less.”
More sublease space hit the CRE office market this year—there was 147 million square feet of subspace space in North America alone earlier this summer, GlobeSt.com reports. Office sublease space increased 76% year-over-year and went up 99% since the beginning of the COVID-19 pandemic during the first quarter of 2020, per Cushman & Wakefield.
When rental rates dropped and “going in” cap rates increase, property value declines. The result is operator’s equity, or the perception of equity, evaporates and lenders become hesitant to refinance the property without additional reserves, according to Hendry.
“The market doesn’t want to pay a price that allows the seller to exit the property,” he wrote. “It is hard to refinance or sell a property when contract rents are significantly higher than market rents and your property is occupied by multiple tenants with staggered lease expiration dates.”
Hendry also noted that this reasoning explains why industrial leases to Amazon are the “coveted prize” in the current market, GlobeSt.com reports.
“They pay higher rents, sign long-term leases, and provide a significant hedge against downward rental rate pressures,” he wrote.
Despite the sobering numbers, Hendry believes all is not lost for the industry—as long people look at the right information.
“Let’s take a deep breath,” he wrote. “There’s hope. Pilots don’t navigate the storm by flying blindly into the night’s sky. Instead, they trust their equipment and data instruments to lead the way. Commercial real estate practitioners should also trust the data to help them guide their clients to smoother air. Having the right data enables you to create a flight plan that minimizes turbulence and maximizes experiences and results.”
Joe Dyton can be reached at email@example.com