Free rent concessions in 94% of US real estate leases

Nine out of 10 office leases offer free rent concessions with the average concession an estimated 6.8 months, a PwC survey has revealed. It comes as the national cap rate for office properties drops to 7.4%, with cities such as New York falling to 6%.

Rent concessions are still a fact of life for the majority of office lease negotiations in the US with 94 percent of investors admitting they still enjoyed the perk.

With the average concession totalling 6.8 months of free rent, the use of concessions in 2010 rose almost 3 percent over the previous 12 months, according to an investor survey by PricewaterhouseCoopers, and was now “unanimous” across the 18 office markets studied in the report. In 2008, 84 percent of survey respondents said they used free rent during lease negotiations, while the amount of free rent increased to 6.8 months in the first quarter of 2011 from 5.8 percent during the same period in 2010.

“As concessions to some degree remain necessary, many landlords are finding it difficult to grow rental revenue and improve net operating income outside of a few key downtown cores,” the report said. Market rents have grown by 163 basis points in the year to the end of March 2011, but it comes on the back of declines of more than 500bp in 2010 and 2009.

The PwC Real Estate Investor Survey also warned that while vacancy rates across all real estate sectors appeared to have stablised office and industrial occupancy rates and rents were not expected to “grow back to 2007 levels until 2014 and 2015, respectively”.

Cap rates were one factor helping prop up values for some central business district (CBD) assets, with overall cap rates for office properties dropping 1 percent over the past year. “Rates for the best properties are dropping, while they are still increasing for the worst properties,” one investor said. Manhattan had seen the greatest level of compression with cap rates for CBD offices currently at 6 percent, compared to 6.48 percent in Washington DC and 6.81 percent in San Francisco.

Mitch Roschelle, US real estate advisory practice leader at PwC said investors had sensed the industry was moving past the bottom of the cycle, but that improving fundamentals were “slow and uneven at best”.

“However, as investors become more confident about the long-awaited recovery of the industry, they are eager to get deals done,” Roschelle added. “This bodes well for the industry as the volume of capital chasing deals is expected to increase in all sectors as investors work to deploy capital before interest rates rise, overall cap rates increase and the industry shifts more in favour of sellers.”