Dealing with ‘downtime’ in the commercial real estate market

Mike Attiani

I could spend the next few hundred words discussing the current economy, but that horse is dead, and has been beaten beyond recognition. Since the economy is not within our control, let’s discuss what can actually be done today to help preserve value and property viability, like tenant retention.

In terms of cash flow, tenant retention is almost always beneficial to re-tenanting. If a tenant must be replaced, leasing commissions tend to be doubled; tenant improvements can be more than quintupled, and “downtime” could be significant.

Downtime is the gap between the time a prior tenant stops paying rent and a replacement tenant begins paying rent. This is a hidden cost of tenant retention because it’s not a direct out-lay by the landlord, but rather a gradual erosion of cash flow caused by diminished revenue.

During a down economy, downtime tends to become protracted as demand for vacant space declines. This lack of demand also translates to landlords offering increased tenant concessions (i.e., moving allowances, free rent, etc.) to remain competitive, which exacerbates the effects of downtime even further.

For example, in a good economy, downtime may be as little as two or three months, but in a down economy, this number could stretch to 24 months, or more. Such lengthy downtime could jeopardize the stability of the property.

During a stable economy, when tenants tend to be healthier, tenant retention is more focused on encouraging tenants to stay beyond their initially prescribed lease term. These days, because tenants are struggling, tenant retention challenges can occur anytime, as tenants begin to consider closing their businesses out of necessity, and breaking their leases.

It is during these troubled times that the property manager’s role becomes increasingly more vital.

An effective property manager recognizes the symptoms of struggling tenants, and begins working to address those risks early in the process.

There are certain industry-standard metrics for retailers, for example, that foretell whether or not a merchant’s sales can sustain them. There are other less-quantifiable methods, also: Have inventory levels diminished? Has staffing been drastically reduced? Has foot-traffic been reduced to a trickle? How are sales trending year-over-year, or month-over-month?

The same sort of logic can be used for office tenants. Are there a lot of empty desks? Is the office suddenly closed one day every week, or a couple weeks during the summer?

These analyses can be performed early in the process, before rent starts coming in later, or stops altogether. As is almost always the case, being forewarned is being forearmed.

By catching these trends early, the property manager can begin strategic discussions with the client and leasing agent to determine a plan for either retaining the troubled tenant, or getting a jump on finding a replacement tenant – better to start the clock on the downtime a few months before the current tenant becomes a former tenant.

In order for any of this to happen, the property manager must be on his or her properties, walking leased spaces and speaking with tenants. That’s the first step toward tenant retention in any economy, but is especially crucial when times are tough.

Part of Colliers’ competitive advantage is knowing what the metrics are and how to interpret them, as well as what strategic options might be available if retaining a troubled tenant is the chosen tactic, so I can’t provide more details here in this article. However, it’s important to recognize that options do exist, and for the right tenant, there are usually ways to work through the bad times.

Above all else, though, now is the time to get out and pound the pavement. Be on-site more often. Secret-shop your tenants more often. Ask the tough questions and try to identify risks before they become issues.

No one likes to admit his or her business is struggling, but when an olive branch is extended, most sane people will accept the offer. Help can take many forms, but the mere fact the landlord is opening the discussion can mean the difference between partnering with a tenant and being adversaries.

Although tenant retention is critical, the property manager must also remain focused on the single-most important aspect of the job: meeting owner objectives. In most cases, more than one tenant at a property will be at risk in this economy, and the property owner may not have the means to pursue tenant work-outs.

Property owners are under greater strain now than they have been in years, especially those who purchased their properties during the recent boom, and have suffered unanticipated vacancy and lender difficulties.

In those cases, an experienced, effective property manager can be the difference between the property surviving or failing during this downturn.

This column was written by Mike Attiani, director of property services at Colliers International in Boise.