One Key to Attracting Office Tenants? Less Debt

With the U.S. office market in flux for the past few years, questions focus on attracting and retaining occupiers. The prevailing wisdom is that newer spaces with high-end amenities are the method.

However, according to an Avison Young article, more companies prefer landlords with less debt. “Tenants and their brokers are increasingly scrutinizing landlords’ capital stacks,” according to the article. “They are putting debt status high up in the RFPs as one of the first line items.

“Regardless of a building’s ‘class,’ tenants are concerned about a landlord’s ability to perform,” Avison Young’s Principal – Landlord Representation, Office Leasing, Occupier Services Mark McGranahan told Connect CRE.

McGranahan, who co-authored the article, pointed out that many newer buildings require higher rents to service higher debt structures. These buildings are also attracting new tenants. “That said, it will remain to be seen whether in five to ten years how they perform, based on how they weathered the storm,” McGranahan said.

The TI Conundrum

The article explained that some of the newer Class A properties on the market offering higher-end amenities are “struggling under the weight of loans that cost more than their buildings’ current value.” As a result, these overleveraged owners “deter companies unless they escrow tenant improvement funds,” the article said.

Those TIs are important to many companies and sometimes more critical than a rock-climbing wall or virtual yoga studio. This is especially the case with financial services and law occupiers. In Los Angeles, firms like to customize their spaces to the tune of $150 to $250 per square foot. “If they can’t find a new construction building that adequately meets this criteria, they are likely to stay put or even move to an older property,” the article said.

McGranahan added that tenants pay a premium for newer buildings with the expectation that it will be maintained at a high level throughout the lease period. So if a high-leveraged building ends up back in the lands of a lender, “it might not be maintained in the same manner as the developer who had the vision for the project,” McGranahan commented.

Class B Appeal?

But McGranahan cautioned that overleverage concerns don’t mean that occupiers will suddenly flock to Class B buildings in droves. A lot depends on the tenant. “The budget tenant is always looking for a lower rate,” he explained. “Most tenants are looking for a better ‘experience’ in the post-COVID world to get their employees into the office.”

Regardless of whether an occupier wants an overall lower lease rate, a guarantee of TIs or attractive amenities, it all boils down to one thing. “Tenants are concerned about a landlord’s ability to perform,” McGranahan said.

The Takeaway

The article concluded by indicating that “the best fit for you might not be what makes headlines,” stressing the importance to occupiers of thinking through their employees’ wants and needs. McGranahan said that the increase in interest rates and a decrease in asset value should also prompt occupiers to vet the landlord. “Make sure they can perform on their obligations, which include capital to improve the space and building maintenance,” he said.

Meanwhile, building owners should take steps to reassure potential and current occupiers. Said McGranahan: “The well-capitalized owners should be proactive and let prospects know about their financial stability.”