Moody’s Analytics forecasts that as we proceed into 2021, vacancy rates will continue to rise. Predictions suggest that the U.S. office vacancy rate will hit a historical high of 19.9 percent next year, surpassing the previous record high of 19.7% in 1991. Not only is COVID-19 impacting the market, but so have recent increases in city regulations. The result: Landlords are losing negotiation power with tenants. Consequently, we have seen a shift in 2020 leasing activity between tenants and landlords.

• Tenants are finding it challenging to fulfill lease obligations
• Tenants have increased demands for tenant concession
• Landlords have experienced increased downtime

Let’s take a closer look!

Tenants are Struggling to Fulfill Lease Obligations

The pandemic has had a domino effect on real estate with countless triggers: mandated shutdowns resulting in retailers temporarily closing their doors; stay-at-home orders resulting in vacant office space while employees work from home; restrictions on travel and public health concerns resulting in a decline in demand for hospitality; and rising unemployment rates resulting in late or missed payments by multifamily tenants. For investors, this means it’s time to prioritize avoiding vacancy and facing the declining demand for CRE.  An important starting place is to reevaluate each tenant’s balance sheet and renegotiate their lease terms. Even if it means meeting tenants where they are, investors should focus on keeping cash flow positive for the next twenty-four months. During negotiations, tenants should consider the following:

Retailers Have Experienced Lost Revenue Through 2020

Coresight, a global market research firm, estimated that over 25,000 stores would close in 2020; multiple nationally recognized brands even filed bankruptcy, including California Pizza Kitchen, Neiman Marcus, Chuck E. Cheese, 24 Hour Fitness, and many more.

Landlords owning retail properties should consider negotiating with tenants and providing reduced rent. As retailers slowly begin to open back up, they are motivated to re-engage with their customers. They just need aid in recovering their lost profits. Landlords can work with tenants in providing a short-term solution by reducing rent, with the plan to renegotiate every three to six months. This will allow landlords to preserve equity in their property in case they decide to sell.

Office Vacancy Continues to Trend Upwards

Fear of the spread of COVID-19 has caused employers to transition to working from home. As time goes on, companies are recognizing improvement in their bottom line thanks to reduced operating costs. As a result: Many businesses are shifting to a part- or full-time work-from-home business model.

Landlords eager to keep their occupancy rates high are advised to work with tenants to accommodate their new mindsets. Providing more flexible office space or the option to downsize can help landlords keep tenants during their transitions. However, landlords in this sector should not rush to lower rental rates. Instead, they should assess the tenant’s industry to determine if a reduction would improve their retention rate.

Industrial Spaces Increase in Demand

Not all tenants have struggled during COVID-19. In fact, we have experienced an increase in industrial development through 2020. A surge in online shopping paired with renewed factory production and improvements has allowed industrial assets to outperform compared to alternative CRE asset types. Rental rates have increased throughout the year, providing an opportunity for investors seeking higher returns. The biggest challenge some tenants have faced is a lack of inventory due to global trade restrictions. However, increased domestic manufacturing has aided in overcoming low inventory.

Due to the increasing demand for industrial space, landlords should leverage their position. Staying updated on current market trends – For example, understanding where the next Amazon fulfillment center will be – can help landlords understand where their property value is trending.

Increase Demand for Tenant Concessions

With the exception of industrial space, 2020 has witnessed an increase in demand for tenant concessions, including significant tenant improvement allowances, free rent, and discounted coupon rates. This trend has been attributed to accommodating companies declining revenue and landlord’s eagerness to avoid vacancy.

In the office sector, reconfiguration of office spaces to accommodate COVD-19 safety measures has been a significant aspect of tenant improvements. Companies seek larger spaces to allow for social distancing and are reducing their need for communal spaces.

Increase Downtime for Landlords

Vacancies remain high due to the shortage of tenants. The average time of properties on-market has grown to 7 months in Orange County. Yet, occupancy can be pushed out 10 to 15 months if construction is required. Tenants are, therefore, prioritizing spaces that are ready for occupancy within 2-4 weeks. To accommodate these new demands, landlords must adhere to commercial real estate marketing practices, prioritizing the tenant’s ability to navigate through the coming twenty-four months. Uncertainty related to legislative changes, and COVID-19, have required landlords to become more flexible on office space. They have also been forced to reduce their turnaround time for tenants looking for short-term leasing opportunities.

CRE Investors Preparing for 2021

Following a decade favoring landlords, 2020 has proven to be challenging for CRE investors. Staying up-to-date on revolving trends, especially during times of such economic volatility, will be necessary for investors to secure their equity moving forward. The best way to stay updated on current trends is to connect with a local broker who can ensure that you are educated on matters impacting your portfolio. To stay posted on CRE trends impacting Orange County, contact us for your market updates.