It's Cheaper to Keep 'em

An economic ill wind is blowing a darkening cloud over most commercial real estate markets. Vacancies are rising in the retail, office, industrial and multi-family sectors. Retail stores are closing at a faster pace than new stores are opening. Net absorption is stagnant or falling. Signature development projects are being increasingly mothballed, delayed or cancelled. Sales of investment grade commercial real estate have swooned. Finally, commercial real estate finance markets are effectively closed to all but the most conservatively underwritten deals, investment properties that show strong existing net operating income, and borrowers with the most pristine balance sheets and income statements.

The rules and assumptions of the commercial real estate game have changed. How should property owners and property managers adapt? The best strategy for these difficult times may be summarized by the words of an old soul song, “It’s cheaper to Keep ‘Em.” Specifically, given the tremendous uncertainty in the overall economy, it is cheaper to keep your best tenants than to seek replacement tenants. Here are three specific strategies that I recommend:

1. Listen to your tenants.

Tenants are businesses. Do you, as the property owner or property manager know anything about your tenants’ businesses? If you don’t, then you should begin closing your knowledge gap by meeting all of your tenants. Visit their web sites. Walk through their office space, or stores, or warehouses, or factories. Learn how they find business opportunities, produce their work product and then receive payment. With this knowledge, a proactive landlord can tweak building operations to greatly aid a tenant’s productivity. For example, a video intercom system connected to an electric door strike may facilitate after-hours customer visits and deliveries. Increased customer loyalty and revenue due to increased convenience may increase your tenant’s revenues and competitive stance while cementing that tenant’s commitment to remain in your building. Your tenant's business is your business.

2. Pay attention to “Curb Appeal.”

Tenants, clients, customers and employees generally enjoy visiting properties that have a certain class A quality, appearing to be professionally managed and cared for with great attention to the details. I call this the “Disneyland Effect.” Why? In 1993, my young family visited Disneyland near Los Angeles. My daughter was terrified of Mickey Mouse but loved the Tea Cup ride. Her father, on the other hand, was amazed that this amusement park, originally opened in July 1955, featured grounds and infrastructure that were maintained immaculately. Even the 1950’s vintage lavatories were bright, spotless and fresh. As an owner or property manager, do you know if your property exudes the Disneyland Effect on tenants, visitors and neighbors? Curb appeal can be a strong reason for existing tenants to renew or expand in your building. Curb appeal can also work magic in attracting new tenants.

3. Thou shalt cover thy expenses.

Having recently come out of a real estate bull market where owners enjoyed leverage over tenants and buyers, some owners and property managers are having a tough time transitioning to the current near depression-level economic conditions. The owners and property managers who will best survive these challenging times are those who understand that “thou shalt cover thy operating expenses.” More specifically, now, unlike at any other time, owners and property managers need to understand that lease-up risk is very real and very risky. Just as the average number of days a house sits on the market unsold has increased in some markets, so too has the average lease-up period required to find a qualified commercial tenant. Don’t wistfully look back after a twelve month vacancy period and wish that you had agreed to that request for one more month of free rent or another 50 cent reduction in rent or a three year rather than a five year lease term. For example, a prominent multi-family property owner had a large one bedroom apartment that had not leased after being marketed for ten months. Prospective tenants didn’t think the unit was worth the $1,190 per month asking rent, when the market for slightly smaller one bedroom apartments was $950. Recognizing this market perception, the owner reduced the price to $995. Better to receive $11,940 in annual rent (83.6% of pro forma rent) than receive nothing. The unit was leased after being marketed for one week at the reduced rental rate. Be flexible and cover your expenses.