U.S. office markets are suffering from soaring vacancy rates, a record amount of available sublease space, and rising defaults. But curiously, office rents are holding steady or even climbing.
Average U.S. asking office rents are $35.24 a square foot, compared with $34.92 in the fourth quarter of 2019, according to data firm CoStar Group. Higher asking prices are a reflection of the seemingly oddball way the commercial real-estate market works.
Rents are a critical metric used by lenders and others to determine the value of a property. Owners will do everything they can to avoid cutting them, even if it means keeping space vacant because the rental prices deter prospective tenants. Landlords who cut rents significantly to fill empty space “would significantly reduce the appraised values of their buildings," said David Bitner, the head of global research for Newmark Group, a commercial real estate services firm.
“This in turn could lead to a covenant default on their loans or at minimum would make it harder for them to refinance." Office rents are expected eventually to tumble, probably after owners and lenders are forced to restructure mortgages or sell distressed properties. For now, landlords are trying to justify the elevated levels by lavishing new tenants with expensive interior build-outs, months of free occupancy and other incentives. “I’ve even heard of a year of free rent for a 10-year lease term," said Phil Mobley, CoStar’s national director of office analytics.
In the past, the standard free rent in many markets was one month for every two years. Some say the strategy is being stretched to the breaking point. Office vacancy is at record levels and continuing to rise because companies that adopted flexible
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