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Office Market Tenants May Have Fewer Options Than Once Thought

With vacancy rates in the office market at record-high levels, it would seem that the options for tenants are endless. But that might not be the case.

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According to ""Grubb & Ellis"":http://www.grubb-ellis.com/, a real estate services and investment firm based in Santa Ana, California, the amount of available space in the U.S. office market may be overstated, giving tenants fewer realistic alternatives than previously indicated.

In a phenomenon dubbed ""zombie buildings"" by Grubb & Ellis researchers, there are many properties that have significant capital constraints, and landlords of these buildings are therefore unable to fund market-level tenant improvement allowances and commissions. This, Grubb & Ellis said, adversely impacts their ability to compete for tenants.

""Now that the values of many properties purchased during the peak of the market have fallen below the balance due on the loan, some landlords are too capital-constrained to offer the tenant improvement allowances and other concessions necessary to attract tenants in today's marketplace,"" said Robert Bach, SVP and chief economist of Grubb & Ellis.

Bach said one caveat to this trend is that the wave of foreclosures was much less severe than anticipated. Instead of banks taking distressed asset back, they're avoiding those write-downs by helping landlords keep their assets, he said. But still, the fact remains that many landlords are unable to offer the kinds of tenant improvement allowances and other concessions that require capital on hand, Bach explained.

Grubb & Ellis studied the trend of ""zombie buildings"" in key markets across the nation, including Atlanta, Boston, Chicago, Portland, and Texas.

In Atlanta, some landlords are handing their keys back to the bank, prompting operational challenges as properties transfer ownership. In addition, amenities such as cafes, restaurants, sundries shops, and dry cleaning services normally associated with Class A and Class B+ buildings are at risk of ceasing operations due to decreased foot traffic.

Researchers said the Boston market in particular is seeing the active investors of 2006 and 2007 challenged by decreased property values, causing several ""trophy"" office buildings in the area to go back to the lender. And several other landlords have been unable or unwilling to make capital improvements to their buildings, removing those from broker tours as well.

In downtown Chicago, the landlords holding as much as 20 percent of the office inventory are not in a position to compete aggressively, but the landlords in a stronger financial position are actually able to keep asking rental rates at higher levels than would otherwise be achievable, researchers found.

And in downtown Portland, a large portfolio of historic properties is currently in bankruptcy, making 15 percent of the Class C space in the downtown market not competitive due to financial uncertainty. For deals that do go through in this area, financial records are being requested on both sides of the table, Grubb & Ellis said. Landlords want to make sure their tenants will be viable for the full term of the lease, and some tenants are even requiring a letter of credit from landlords until all tenant improvements are completed.

Researchers also found that Texas, which is considered to be a healthy market, is estimated to have more ""zombie buildings"" than well-capitalized properties. However, unlike many other markets, tenants in Texas are still renewing leases and touring these buildings. But these same tenants are also frequently securing a back-up lease for cases in which negotiations with the ""zombie building"" landlord fall apart.

About Author: Brittany Dunn

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