Why does so much space remain vacant?
So I'm currently looking for a Boston office for my company as our current 5-year lease is approaching its end.  We're going to be renting 6-8K sf for 5 years and we've been looking in three different areas around Boston.  For the type of space we're looking at, costs vary from high 50s to mid-70s.  My colleagues have seen a lot of spaces and this week I have personally seen 4 "finalists."  One thing I noticed is that some of the buildings would have 10-30% of the space unleased and it was typically that way for 6-12 months.  It seems like a really tight market so why are landlords and building owners holding out for presumably a few more dollars per square foot and losing out on a lot of cash?  I would imagine a building with 20% vacancy is not profitable, no?  What am I missing?  Conversely, are these landlords that I want to lease from?
[{"id": "f1fr619", "text": "Nice question!  6-12 month downtime is quite common and actually part of the assumptions the owners make when buying property.  An 80% leased building can certainly be generating positive net cash flow so some owners may prefer to optimize the rental rate they can lock in for the term of the lease.  Others may be looking to sell the building in the next few years so they are trying to maximize the in place rent rates so they can get a higher exit price.", "replies": [{"id": "f1frpk9", "text": "Are there any rules of thumb around this?  Like it you have more than 25% vacant you're losing money or if you discount rates 10% you lose 5X that on a sale (I'm just making numbers up as examples)?  If something has been sitting vacant for 10 months, does that motivate the owner at all?\n\nI actually have two other questions that you might know the answer to:\n\n1. For TI's, it seems like you can get a healthy allowance for building out stuff.  But that doesn't include pre-fabricated \"phone booths\".  Strangely, the pre-fab phonebooths are cheaper than building out small office equivalents.  Is there away around this (to have these \"fixtures\" counted as TI's)?  Seems weird to pay more for a less useful product for accounting reasons.\n2. Other than TI's, are there other concessions that are easier to ask for than a rate reduction on the lease?\n\nThanks!", "replies": [{"id": "f1ftqbw", "text": "Free rent for a period at the beginning of the lease is not unheard-of.  If vacancy is above market norms, some LLs might be willing to negotiate.  Depends a lot on tenant quality - e.g. a newer business without a strong personal guarantee is unlikely to get much if anything off asking.  They may not even get to rent at asking price.  As for TI, consider how useful it is to LL if/when you leave.", "replies": [{"id": "f1g73aj", "text": "Yes, I heard today that 1-3 months of free rent before the 5-year lease is not uncommon right now.", "replies": [{"id": "f1gjnlo", "text": "Try asking for 5 months of free rent - 1 month per year of term.\n\nI don't know if you would get it, but thats a common assumption in the underwrites.", "replies": [{"id": "f1ha8ns", "text": "Thanks!", "replies": [], "depth": 6}], "depth": 5}, {"id": "f1hsomp", "text": "Most landlords are ok to swap TIs for free rent", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}, {"id": "f1ftuk2", "text": "Depends on the type of office buildings and owners you are referring to. An owner can pay the operating costs with low occupancy if their cost basis is very low.  But to give you something to work with, anything under 80% occupied for a couple years would be worth digging into.  Not necessarily bad but find out why - is the space just not a good fit for users in the market? Is the owner in financial trouble on other properties? Are rents moving up quickly and the owner is waiting to optimize?  Talking with existing tenants can tell you a lot about whether the owner/manager sucks.\n\nI\u2019m probably not the best to address your other two questions since I have experience on the asset management / fund side of an investor and not a lot of leasing.", "replies": [], "depth": 3}, {"id": "f1gv6f0", "text": "The most important part is building value. I'm guessing average cap rate for that asset class and location is about 6%. Basically every dollar of increased rent is going to increase NOI of the building directly, dollar for dollar. So a $1,000 more rent per month increases the value of the building by $1,000 * 12 months / 6% cap rate = $200,000 in building value. You could also realize that value by doing a cash out refi, not just a sale. So free rent and TI can be great long term if you have the cash to do them. \n\nThere's no rule of thumb for vacancy like you mentioned because it is mostly dependent on what the owner paid for the building and how much leverage (how big a mortgage, maybe a second mortgage, maybe a bad deal with pref equity investors) they have. Both of those vary a lot. If you know the owner bought the building recently, they are likely to have a higher cost basis and less flexibility than someone with comparable space who has owned for a long time.", "replies": [{"id": "f1hajl3", "text": "That makes sense.  One one of the places we looked at the agent said that the owner had owned the building for 20 years and \"didn't really care\" if it was all rented or not because they were covering their costs.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "f1ftd1u", "text": "Having vacancy for 6-12months is baked in to your assumptions, and you hold out for the tenant quality &amp; rate you're targeting.  As long as quality tenants usually stay, it works out to be a fairly low vacancy percentage overall.  Having the wrong tenant (even with a short lease or kickout clause) makes it a little harder to get the right tenant in.  Also, when banks review your rent rolls, they understand the vacancy but may not like seeing low rental rates.  Depending on the financing situation, this might be disadvantageous.", "replies": [], "depth": 1}, {"id": "f1fybvp", "text": "Usually landlords would prefer to lease to fewer high quality people than many lower quality people. So sometimes you have landlords holding out three floors waiting for a whale of a tenant to lease them all up rather than leasing 1/4 of a floor here and there. \n\n10% office vacancy  is not that bad, and 6-12 months is also not that bad. \n\nIf I am spending $60/PSF to renovate a floor for an office tenant, it is going to take 6 months or more. I am not going to do that if I am not sure if the tenant is not going to be around in 3 years, I would rather wait for the right tenant. \n\nPlus you need space if a tenant decides he needs to expand. You are looking at 8K of office space now, and are locked in for 5 years. What if your business grows and you need another 8K of space. What are you going to do? \n\nYou are going to talk to the landlord and lease that space from him, and you will gladly do so, since it would cost you a bunch of money to lease space at two different offices across town. Or say you have an office tenant who is leasing 40K of space, and is renewing and wants to renovate their office for the next 10 years. Their sign is on the building so they are not going anyplace. You move them to an unoccupied swing space so you can complete the renovations and then move them back in in 8 months once the construction is done. \n\nIf you don't do this, they will leave, and you will need to find another big ass tenant, which is hard. \n\nSo to answer your question it is about being flexible for your existing tenants if they need to expand or need short term space, it is about holding out for larger tenants instead of dealing with a bunch of shoddy tenants. \n\nThe building managers get paid on how well their building is performing relative to other similar buildings. If everyone has 10% vacancy rate, you still get your bonus. If everyone has 10% and you are at 20%, well, you are talking to everyone in the building seeing if they want to expand, making sure nobody is planning on leaving and figuring out ways to bring your vacancy down so you can get your bonus check.", "replies": [{"id": "f1hap1q", "text": "It's funny how when they show space to you they talk about how there is \"Twitter and Spotify in the building\" as if I care about that.  It's clear that it matters to them (this \"quality\" attribute you mention) and I guess they think everyone cares about it.  LOL. \ud83d\ude02", "replies": [{"id": "f1i59g1", "text": "It is validation that their high rents are justified if other name brands are paying them. And if you are a tech company there may be certain network effects of being near similar companies. Just means you have to pay your employees more too or they will jump to those other companies. \n\nI guess if impressing clients is important than class a office kinda makes sense, but I also kinda figured we would all be working from our houses using cloud computers in the future, but I guess we will see. \n\nAnd don\u2019t get me started on \u201ccreative office\u201d", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "f1grulx", "text": "Have you considered bringing your business to Worcester? It's worth a consideration for sure and would love to give any resources necessary!", "replies": [{"id": "f1haxes", "text": "I can't move 2 miles across Cambridge without losing people \ud83d\ude02 so it would be funny to see everyone's face if I told them we're moving across the state!", "replies": [{"id": "f1hay6u", "text": "I can't move **3.2 kilometers** across Cambridge without losing people \ud83d\ude02 so it would be funny to see everyone's face if I told them we're moving across the state!\n\n_____\n\n ^(I'm a bot) ^| ^[Feedback](https://www.reddit.com/message/compose?to=Ttime5) ^| ^[Stats](https://www.reddit.com/message/compose?to=Bot_Metric&amp;subject=stats&amp;message=Sent%20this%20message%20to%20get%20some%20stats) ^| ^[Opt-out](https://www.reddit.com/message/compose?to=Bot_Metric&amp;subject=Don't%20reply%20to%20me&amp;message=If%20you%20send%20this%20message,%20I%20will%20no%20longer%20reply%20to%20your%20comments%20and%20posts.) ^| ^(v5.1)", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "f1gufvc", "text": "That's a good question. I was a Senior Vice President and broker for a national firm and then started a commercial real estate technology company.\n\nSo... although it seems awkward, it makes a lot of sense.\n\nThese landlords are mostly institutional owners. When they buy a building they base their profit proformas on a 90-95% occupancy. BUT, that's not for a single building, it's for a portfolio of buildings.\n\nSee, these institutions have funds, and the fund owns various buildings, which means that if the buildings as a collective have met the 90-95% occupancy, they don't have to lease anymore space.\n\nSo 2 out of 3 buildings can be 100% leased, and the 3rd building can have 20% vacancy, but who cares? They've already hit profit quota, so anything above it is gravy.\n\nHow do you compete in an environment like that, it's called, Relationships. Find out who the decision makers are at the landlords office, tell your broker to set up an in person meeting, sell them your vision and you could turn a pig into a princess.", "replies": [{"id": "f1haspu", "text": "Nice. Thanks.", "replies": [], "depth": 2}], "depth": 1}, {"id": "f1i1cqq", "text": "A couple extra months of vacancy don\u2019t effect proforma as much as taking a hit on the rental rate. Also some owners get caught thinking their building is nicer than it is and refusing to rent or anything less than the number they have in their head", "replies": [], "depth": 1}, {"id": "f2on5s5", "text": "Come to Paterson,NJ we have great location in the 2nd biggest city in New Jersey. A lot of good opportunities and great tax advantages.", "replies": [], "depth": 1}, {"id": "f3ueufz", "text": "1) It is very expensive to build out space. The economics of a prospective tenant may not justify the costs of construction so no lease happens.\n\n2) A building is underwritten with a certain rental rate for both investors and the bank. As office leases can be very long term, if a landlord agrees to a lower rental rate now and rates increase in the coming years, they will never recover that difference in income. This can mean it's worth waiting with vacant space for some time for a higher rent tenant to come along.\n\n3) Some vacancy can be useful for building renovations or moving/consolidating tenants in a building to free up larger blocks of space for new tenants.\n\n4) There are often a reduction in property taxes if space is vacant, making it more palatable to a landlord to have empty space.", "replies": [], "depth": 1}]