After a commercial rental unit (CRU) has been on the market for a period of time, a discussion should take place between the broker and vendor to explore potential reasons.
There are many factors that can contribute to a lack of success in locating a suitable tenant. Has the space been properly marketed?
Does it require updating, refreshing (you only get one chance to make a first impression) or the demolition of obsolescent improvements? Would rental incentives such as free rent or a tenant improvement allowance be appropriate?
One question that needs to be a part of that discussion is: Is a price adjustment required? There isn’t necessarily a simple answer to that question. However, we’ll explore how that discussion might look.
What do the comps say?
A regular review of the details of recently completed lease transactions and the current asking rates for comparable properties is required to make an educated pricing decision.
I’ve witnessed markets where vacancies have slowly grown over a period of time without significant price fluctuation.
A change can happen quite rapidly, however, when two or three landlords have decided they’ve been carrying the property too long and choose to drop their price to secure a deal. When that takes place, it can have a real effect on the rest of the market.
Could a pricing decision affect future negotiations?
Let’s say I reduce my list price on a CRU to a number which is less than what a tenant in the next bay is paying. You can guess what will happen when I try to negotiate a lease renewal with that adjacent tenant.
A landlord must assume the lease terms negotiated with a new tenant may at some point be disclosed to an existing tenant.
Again, I don’t have to tell you the potential impact of that disclosure in negotiating with the new tenant if the landlord has dropped the rate considerably.
How does a pricing decision affect value of the asset?
There are three primary methods of calculating the value of commercial real estate: the income approach; cost replacement method; and comparable approach. To calculate the market value within the income approach, net rental rates are applied to a capitalization rate.
If a landlord has a goal to either sell or place a mortgage on commercial real estate, it may be beneficial to wait for a slow market to subside.
If you’re a tenant or plan to lease space in the future, and have read this article in spite of the title, you now have a better understanding of why landlords will often prefer to have their building sit vacant.