Big Concessions Makes Credit Analysis an Emerging Imperative

Competition for tenants in Class A office space is hot across primary commercial markets. In many cases landlords are unable to continue hiking rents. They have been, however, increasing concessions to lure tenants and remain competitive by improving amenities, according to research published by brokerage firm Savills Studley on New York City office space. This approach is one lever real estate companies can pull to increase the likelihood a tenant executes a lease, but it effectively increases the leverage a landlord and its partner have in a deal. Thus, the importance of commercial tenant credit analysis increases with the value of the concessions as lease economics weaken from ownership’s perspective. The longer breakeven periods mean that landlords will potentially carry exposure to tenants through new and uncertain business cycles.

Underpinning the increased concessions is the notion that commercial credit is not likely to improve over the near-term given the prospect of rising rates and the recessionary signals that bond markets are sending to the rest of us. If landlords continue beefing up concessions they will likely be increasing longer-term cash flow risk to meet near-term objectives. We believe concessions should be aligned more closely with a tenant’s individual credit profile in the current market environment, and that landlords that stretch on concessions today may be diminishing long-term yield.

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