5 Reasons Rents Remain High Despite Shrinking Demand

The office market seems like a paradox. Businesses are downsizing, and vacancy rates are soaring, yet rents are slow to go down. Here are five reasons why: 

  1. Preserving Property Value: Rental income (or potential income) dictates an office building’s value. Landlords fear that lowering rents will trigger a domino effect, significantly reducing their property’s worth. 
  1. Loan Defaults: Most office buildings have mortgages. A sharp rent decrease could make it difficult for landlords to meet their loan obligations, potentially leading to defaults. Add Increased costs—insurance, tenant Improvements, and operating expenses—and the landlord’s plight is exacerbated.   For landlords, the silver lining of increased Tenant Improvement costs is that some tenants can’t find a new space that doesn’t require a huge TI, so they end up renewing.  
  1. Playing the Long Game: Landlords hope this is a temporary blip. By keeping rents high, they maintain a bargaining chip for future negotiations when the market recovers. 
  1. Incentives Over Price Cuts: Instead of lowering rents directly, some landlords offer lavish build-outs, free rent periods, and other perks to attract tenants while maintaining their headline rent figure. 
  1. Short-Term Leases & Renegotiations: The current high rents reflect existing leases signed before the downturn. As these deals expire, companies will renegotiate and predominately downsize, putting downward pressure on rents in the long run. 

While high rents may persist, the market will likely correct itself. Distressed property sales at steeply discounted prices will force other buildings to lower their rents to keep their tenants or to attract new ones. I think this will take 3 to 5 years to play out, and unfortunately, the short term will be painful for many office building owners.  

One Building to watch:  801 K Street, also known as the Darth Vader Building, will probably sell for less than $100 a foot. Currently, there is over 200,000 SF available, and this will increase when the California Earthquake Authority downsizes and moves to Capitol Mall.