Rents down but early commercial renewals continue

By Ilaina Jonas - Analysis

NEW YORK (Reuters) - In heady economic times when commercial real estate rents are rising, tenants often try to renew leases early to head off the higher prices future agreements are likely to stipulate.

Yet, even in the current real estate downturn, when rents in many markets have been sliding, tenants continue to renew leases years ahead of expiration, and nervous landlords facing refinancing or loans due are a lot more friendly at the bargaining table.

A U.S. economic slowdown, tighter credit markets, stiffer cost controls and greater attention to the bottom line are bringing landlords and tenants to the bargaining table early, a trend that is expected to pick up as rents decline further.

"We haven't seen much drop-off in early tenant renewals," said Steven Durels, director of leasing for SL Green Realty Corp SLG.N, one of the largest owners of office buildings in Manhattan. "In fact, we've done some very big deals where we've done early renewals."

Over the past few years many commercial real estate buyers based the price they paid on anticipated future rent growth and demand. But with some loans coming due and demand crimped in many markets, retaining tenants has become a prime concern for some landlords.

"The reason people do an early renewal is because the landlord is afraid of a vacancy, because he wants to sell the building, he has a loan maturing, or he has some event causing him to make a decision today rather than waiting for three, four or five years out," said Arthur Greenberg, executive vice president of tenant representation company Studley in Washington, D.C.

"ELIMINATING UNCERTAINTY"

"The tenant does it because he wants to take advantage of the landlord's situation," Greenberg said. "They strike a deal somewhere in the middle that's best for both of them, eliminating the uncertainty."

Lenders also are pressuring landlords to fully lease their buildings to ensure they generate enough cash to cover a mortgage or loan.

"Lenders are much more involved in major tenants' leases than they used to be," said Drew Morris, Studley corporate managing director in Houston.

Tenants may be motivated to stay put because, unlike renting, the cost of transforming raw space into sleek new offices continues to climb.

"Nobody in a weak economy wants to replicate their existing space in a different building and spend a whole lot of capital that they wouldn't have to spend if they could stay where they are," Durels said. "That's a huge driver for tenants now."

In New York, such costs can run as high as $250 per square foot. A longer lease enables a firm to amortize capital improvements over a longer period of time.

Many office landlords, including Vornado Realty Trust VNO.N, Boston Properties Inc BXP.N, Mack-Cali CLI.N and Brookfield Properties Corp (BPO.TO: Quote, Profile, Research, Stock Buzz) are expected to see more early renewals.

Evan Margolin, Manhattan corporate managing director for Studley, said that early renewal makes sense if the tenant's needs have changed and the tenant can take advantage of the landlord's situation to fulfill his or her own new requirement.  Continued...