Big wave of lease renewals to roil office, flex markets

The last big hit from the Great Recession should descend on owners of office buildings and small flex spaces this year.

Landlords whose tenants signed five-year leases in 2007 are expected to see many of those tenants downsizing or renegotiating rental rates when their leases come due, says Tim Ruffin, senior vice president of office properties and managing partner of Colliers International's Reno office. Market rates have fallen an average of 50 cents a square foot since 2007, Ruffin says.

As a result, net operating income will drop for landlords many of whom already are struggling with vacant spaces in their buildings while the balance sheets for tenants is expected to improve as they reduce their operating costs.

"Most people need less space now than they did five years ago; we all took way more than we need," Ruffin says. "Tenants will be taking less space and will pay a lower rent level. This probably will be one of the biggest hits to landlords."

Architectural foam manufacturer Stone Canyon Products is a perfect example.

Rob Wellman, Stone Canyon's office manager, signed a lease for 5,000 square feet of flex space at Spice Island Drive at the beginning of 2007. At one point especially when the company was making hundreds of decorative foam structures for the Peppermill's extensive fa ade remodel Stone Canyon's space was too small. However, as business and revenues declined, company owners found themselves facing a crushing $4,000-a-month lease. Stone Canyon last week moved its operations to a 5,200-square-foot space on Cal Lane in Sparks and now pays half the rent, Wellman says.

Colliers International itself is a prime example of downsizing.

In 2007 the commercial brokerage firm leased about 6,000 square feet of Class A office space on Double R Blvd. Today, Colliers needs only about 4,000 square feet, Ruffin says.

Some companies already have subleased some of their vacant office space, but a wide-scale downsizing could negatively impact the region's already high vacancy rates for office properties.

The vacancy rate in office buildings in the Reno-Sparks area was 19.7 percent at year-end, while the vacancy rate in garden office projects less than 10,000 square feet was 24 percent, says a recent report by the Colliers office team.

Keeping tenants is of utmost important to landlords, says Don Welsh, vice president of the office division of Grubb and Ellis|NCG. Welsh says his firm is advising landlords to do whatever it takes to keep their current tenant mix even if it means sacrificing profits.

"We are seeing some very interesting concessions being given, even to the extent that those new lease rates are being offered today," Welsh says. "Landlords are writing off expected income just to keep tenants in."

Landlords of the top-tier office properties haven't lowered rates much, says David Woods, senior associate with the office team at CBRE. Those landlords know they have a desirable product, he says, and they are working with their existing tenant base to renew leases at favorable terms.

"Those landlords are taking the approach that they have a unique product," Woods says. "If a tenant really wants to get a low lease rate they will find it there is a landlord out there that will do the deal for lower than were they are at but for Class A space, owners are succeeding in keeping their rates high because there is not a whole lot of Class A space."

Many smaller companies have taken of advantage of lower leasing terms to upgrade their office locations a "flight-to-quality" but not everyone is interested in moving or downsizing, Welsh says. Changing locations and lost productivity can be expensive. Instead, some firms are staying put at reduced monthly rental rates. Others, Welsh notes, are reconfiguring their office spaces by eliminating private offices.

"If landlords are willing to reset the numbers they are keeping tenants," he says. "I think we are really near the bottom of the drop in lease rates, and we won't be challenged by new construction for some time."

A potential benefit of tenants saving money on lease rates and improving their balance sheets? A spike in hiring additional workers.

"Tenants won't be paying as much in rent, and they may be able to hire somebody as opposed to paying rent," Ruffin says.

Stone Canyon's Wellman says the company will save more than $25,000 in 2012 due to its reduced monthly rent.

"That can be salary for one of the managers," he says, adding that his company probably wouldn't have lasted another two years if it still faced the higher rent payments.