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Caleb Smith: That $12 Office Lease Rate is No Bargain

Caleb Smith

Growing up in New Jersey, we had spring storms, but nothing like the ones we have here. Hail was somewhat synonymous with freezing rain. Electrical storms were fun and rarely life-threatening, and the post storm clean-up was minor. Sure, parts of the state would go without power for a day or so, but rarely were the lights still out when I got home from school. As a result, we did not have the spring assault of questionable roofers trolling the neighborhood looking to perform repairs. (I should note here that although we did not have the roofers, we had other pests, like gypsy moth caterpillars and inchworm webs that would appear like magic out of thin air and touch just enough of your face to feel like a bird drooled, or worse, on you.)

Any North Texas homeowner knows what I’m talking about. It starts with the flyers left in your door handle. Soon it turns into those irritating weekend door bell rings with men in work clothes posing as good Samaritans who will gladly perform repairs for a nominal fee. As many of you know, these are not Samaritans and rarely do they know what they are doing. The name of their game is to get the job, do it as cheaply and quickly as they can, and then move onto the next job. Heaven forbid they take too much time on one roof and lose two other jobs as a result.

What makes matters worse is that by the time the next storm hits, the roof is leaking again and now insurance won’t cover the damage because you did not have an approved contractor perform the work. As for recourse, good luck finding the individual or company that performed the original repair work, they have moved on to the next neighborhood of unsuspecting dupes.

Well, Dallas commercial real estate is in a similar position today. We have just weathered a massive economic storm, and now the Samaritans are at it again. Downtown Dallas got hit harder than most of the city; there were plenty of buildings in questionable repair prior to the storm but now, much of downtown is in need of real repair. Proudly, we at Spire were mostly unaffected—we saw the storm coming, battened down the hatches, taped the windows, and settled in for a barn burner.

Unfortunately, many building owners were unable or unwilling to do the same. As a result, many properties have neglected any real repairs and are being foreclosed upon as a result. Just last week, there was an article mentioning a handful of sizable towers as buildings in or about to be in foreclosure. Believe me, this will be a story told all too often over the next few years. This is when the Samaritans enter the game.

Many tenants looking for downtown office space are being proposed rents that are too low. (I’ll explain the “too” part in a bit.) They are being enticed to go into these damaged buildings with the promise of $12 rates. What they’re not being told is that no capital improvements have been made to the building in years. As a result, they have higher repair costs while getting lower and lower efficiency.

They don’t mention that their contractors aren’t getting paid in a timely manner, which results in poorer future service. They don’t mention that their lenders are breathing down their neck and the only reason they haven’t foreclosed is because they are receiving more money renegotiating a failing loan than the interest they would normally collect. Most important, they are not telling the tenants that they won’t be around in a few years, and therefore don’t give a crap about your comfort or tenancy. They are just looking for a way out without losing their shirt. Obviously, no tenant wants to be in this scenario, but many who fall for the low rent trap will be.

The reason I say $12 rent is too low is because no quality downtown building can make its interest payments with that rate. Bear with me here. The typical building downtown has operating expenses around $9 per square foot. The typical Tenant Improvement allowance for a new 10-year deal is approximately $40 per square foot. This means that after just these two expenses, the landlord needs a minimum of $13 per square foot just to break even. ($40 divided by 10 years = $4 per square foot. $4 + $9 = $13 per square foot. This does not include commissions, legal expense, landlord work to be performed, etc. This is all before the minimum $3 of interest and debt expense a building carries.
As you can see here, in order for a building to cover expenses and interest, an absolute minimum of $16 per square foot is needed.

Why should I, as a tenant, care you ask? Because unless you want to deal with the figurative repair guy to repair the original work, fight insurance, and have the time suck of dealing with it, you should care. It’s true that in an office building you don’t actually have to do the repairs yourself, but this is what you will deal with: Elevator service that is questionable (at best), ugly repairs that lower the quality of the building, poor customer service because the staff is fleeing like rats on a sinking ship. You will be asked to fill out SNDA’s and Estoppels at least twice a year, and you will be embarrassed to have a client show up and see what crappy digs you are in. My suggestion, you get what you pay for.

So when looking for office space consider this, are you going to hire the Samaritan or an approved contractor? A $5,000 roof is a lot less important than a multi-million dollar lease. Now why would you do less for your office where you spend more time than anywhere else?

Caleb Smith is president and owner of Spire Realty Group LP. Contact him at [email protected]

  • Marc

    Never met Caleb, but let’s consider his perspective as he will soon have a host of new Class A office projects coming online in downtown with rates more than $20sf. And what he states in the article maybe true for some downtown buildings/owners/investors, but certainly not all. There are numerous quality buildings that are great for downtown and lease for $12sf or less. These owners recognize the future and identify with the new young culture burgeoning in downtown.

    The foreclosures Caleb is speaking of are typically the over leveraged large Class A buildings that can’t compete in downtown due to their debt load or carry. These institutional investors have and/or will get slaughtered as they over paid with irrational exuberance for their assets.

    Let me be clear, there are a handful of very good operators in downtown that saw the same storm coming, purchased their assets correctly, and that’s why they can be the low cost providers in downtown. Not to mention they can make money on $12 lease rates in quality buildings. One of my best client’s does it at $10sf with free customized build-out because he understands his model. Be the low cost provider, understand your market, and keep the buildings leased with quality tenants that enjoy the cool modern loft offices. Some of his tenants have been with him in four different buildings in the downtown area.

    The good owners understand the culture of downtown much better than most investors and don’t have to circulate fear in future tenants to get them to move to a new building with higher lease rates.

  • bambam

    In other words, this is almost as bad as ***every*** apartment managment company in dallas. seriously, these people are worse than crooks. they’re stupid, mean crooks.

  • Gary

    Marc, pretty sure you guys are talking about two completely different types of office space. Don’t know too many KPMGs or Neiman Marcus types that want to go into a loft office space with limited amenities. Both types have their place and are good for downtown, but that’s comparing apples and oranges a bit.

  • Ed P

    Marc must work for Boxer properties. Or what the poster above said: apples to oranges comparison.

  • JD

    Well said Caleb. If one thinks of his good money and its return….you pay for quality and worry about it once, pay for a sinking ship and it will pester you for the entire lease term…..every day.

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