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August 11, 2017

PSBJ Thought Leader Forum: Hottest Real Estate Markets

Puget Sound Business Journal

Emory Thomas

Seattle and the Eastside are among the hottest commercial real estate markets in the United States. Recently, two experienced commercial real estate brokers (Brian Hatcher, EVP, Kidder Mathews and Zach Zaborowski, SVP, The Broderick Group) held a robust discussion with PSBJ's Publisher, Emory Thomas, about how tenants can best negotiate leases and renewals in a competitive environment.

How far in advance should a decision maker start evaluating their options in a hot commercial real estate market?

Hatcher: A year and a half to two years is plenty of advance time in a market like this. Time goes by really fast so you have to start way out there. Don't wait too long or you may not have any options.

Zaborowski: It really depends on the company's size. If you are a 100,000-square foot tenant or larger, you are likely considering new construction, so start three-four years out. If you are a smaller tenant, it doesn't benefit you to start the process until 12-18 months before your lease expires. The deal will be more favorable if you're finalizing more closely to the execution date because it eliminates the down time for the landlord. We often see mid-size tenants looking over two years out and while it's important to gather as much information as possible, it's difficult to put a mid-size deal together with a lot of time between lease execution and lease commencement

There is much talk that the market is going to run its course in the next 12 months. What inning are we in?

Zaborowski: In Bellevue and on the Eastside, there was skepticism about the market even two-three years ago. Now there's no space in Bellevue and we're already talking about new construction again. I think the best comparison I've heard was from Mathew Gardener (Windermere Chief Economist) when he said we were in the 7th inning of what was likely to be an extra innings game.

Hatcher: Three years ago, everyone was saying it couldn't possibly last and here we are. When quality real estate comes on the market, multiple offers come in. I still see a strong end to 2017 and a strong 2018.

How big a factor is Amazon; Amazon itself and the ripple effects of Amazon?

Zaborowski: It's a complete game changer, especially since the announcement of their Bellevue office. You've seen what they've done in Seattle; it's been insane growth. It seems like wherever Amazon goes, it's not just one stop. There's a continual pattern of growth wherever they establish an office.

Hatcher: Amazon is hiring so many people. They consume goods, hospitality, housing. I think they've only begun to take on the world. The ripple effect in our industry is huge. They are to the Puget Sound area now what Microsoft was in the 80's and 90's.

What submarkets currently present the best opportunity for tenants?

Zaborowski: Opportunity has a different definition for every tenant. However, from a purely economic standpoint I believe there is opportunity in Bothell. Many employers lease space in the downtown core and their employees have to commute or pay a substantial amount to live close by. With current housing and rental prices what they are in the urban core it's hard for many employees to do that. I believe some companies may consider moving their offices to locations with a lower cost of living to better accommodate their workforce.

Hatcher: I'm old school. Location, location, location. There's a reason Amazon is downtown. Most of the young people getting out of college today want to live in the city. But, Bothell, Renton, Federal Way, Tacoma - they are going to continue to grow. They will also have success due to the tightness of Bellevue/Seattle. Google landed across the street from Amazon. They have a presence in Kirkland. They didn't need to do this. But they wanted the workers and they wanted to compete for engineers.

Is there an advantage to be represented by a brokerage firm who represents both landlords and tenants or a tenant-rep only firm?

Zaborowski: You need to hire someone you trust who knows the market and knows how to work with your company to achieve your goals. There are a lot of good brokers out there and it comes down to that individual level of trust and relationship. Every broker has a fiduciary responsibility to fully represent their client's best interests.

Hatcher: Tenants want information. It's not just about unlocking doors for people to walk through. This is my 33rd year. The data we are using today is more data than we've ever needed in all the previous years combined. We believe having data for both helps all clients.

Tele-commuting hasn't overtaken the need for office space and neither has shared office space. Do you see any change coming there?

Zaborowski: If a company is trying to establish a better quality of life or a better work/life balance they're giving employees more flexibility, like allowing employees to work from home. In most cases, I don't think the idea of tele-commuting is driven by cost savings or reducing a company's square footage.

Hatcher: Every company is selling something and collaboration is invaluable. I don't know what Amazon does inside but I know they have massive sales teams. They continue to put their salespeople near each other so they can communicate. The amount of business we do via interoffice collaboration is huge.

What's the average lease length right now? Any thoughts about strategies for what you should be aiming for?

Zaborowski: With new construction, it's inherently higher - 7 to 10 years - because you're moving into a new space that's likely a shell. Both the landlord and the tenant are investing so much capital that shorter term leases don't usually make sense. With existing second generation space, there is still the potential to get 3-5 year deals done for tenants.

Hatcher: If the landlord wants to sell the building, they want longer term leases. Sometimes the last thing you want to do as a company is deal with it again. It's not easy and it's distracting. Whatever market your lease expires in, you take advantage of what you can then. We believe in longer terms.

Have you seen a lot of horror stories where people work themselves into tight spots looking for space?

Hatcher: For tenants that are more static it's not that big of an issue. They will have to pay more money in their renewal. Landlords want to get tenants renewed, too. There's always a fear that if tenants move out what if they don't fill the space? The more growth you have the more trouble you're going to have. If you're locked into a 7 to 10-year term, then what do you do? You better hope you have a landlord who has a lot of space so they can tear your lease up and put you in another space. If you do lease long term, make sure you have a landlord you view as a partner.

Zaborowski: Scenarios where multiple tenants are looking at the same space are occurring more and more often. It's so important to be responsive as a tenant. A lot of deals go sideways because the tenant takes too long to engage or respond. When too much time goes by many landlords will say "why are you coming back now?" It creates an accountability gap.

How do you do your research and due diligence to learn about landlords?

Zaborowski: It's all about experience. You can't start in the business tomorrow and just ask everyone about a landlord and get the quick story. You have to have done deals with all of them and then you know the ins and outs of how a landlord works.

Hatcher: Most landlords today of major buildings are institutional and they do not want tenants moving out of their portfolios. The best thing for tenants to do is become a partner with their landlord. Meet with the landlord before you sign a lease.

How does technology play a bigger role in how you serve your clients?

Hatcher: It's 24/7. Every top broker checks their email before they go to sleep and the minute they wake up. When things move at the speed of light you have to, too. Years ago, marketing was done with a flyer. Now we have VR tours. But, ultimately it comes down to getting on the phone and hammering out a deal. We've asked clients if they want to communicate via social media and they say just pick up the phone.

Zaborowski: Landlords are making important advances with technology - drones, augmented reality, virtual reality, etc. Landlords are in the business every day so it makes sense that they invest capital in new technology to help market their projects. For tenants, it's all about communication.

What are two ways to make a mistake if you're a tenant looking for space in today's market?

Zaborowski: Not planning for expansion, especially if you're a tech or high growth tenant. Landlords want you to grow and prefer tenants that are growing. Space pockets (space you commit to now but you only pay on a portion of for a period of time and then you grow automatically into it) can be key. In a tight market, it would be normal to think that type of concession is going away. However, many landlords are almost always still interested in discussing this. Other types of expansion, like a right of first refusal - you want to get those too.

Hatcher: Understand the lease document. I think a lot of tenants only look at part of the lease - rental rates, size - and want to sign. I would say 20-30% of your entire lease payment has to do with the expense part of your lease. An option to renew - it's amazing how many tenants don't seem to care about that. I guarantee that in this market tenants want that.

Zaborowski: Option to renew can mean everything because it can be the difference of you getting bumped out of your space when another tenant wants it. It's also important to evaluate the other tenants in the building who may potentially go after your space for their growth. Since most options are never exercised, it's something you may never use but in the small chance you need to, you will be very happy you have it.

Hatcher: If Apple has a floor in your building and your lease is up in 1 1/2 to 2 years you might want to start looking at the option to renew now.

Let's look at the dynamic between Seattle and Bellevue. What should we be aware of?

Hatcher: I don't think Bellevue needed a shot in the arm but Amazon opening over there has raised a lot of eyebrows. I can't imagine they only want to put one group over there.

Zaborowski: I think a lot of it is based on where decision makers live - you have a ton on the Eastside and they want to be over there. But younger talent may want to be in Seattle. That drives your decision making.

There's been an influx of new brokerage firms coming in to the Seattle area in the past year. How does that affect existing companies?

Hatcher: There's enough business for everyone who works hard. Kidder Mathews has been around 50 years and we've really done well. New companies have a lot of work in front of them and we wish them well.

Zaborowski: It's great to see more brokerages focusing on Seattle because it further validates us in the national marketplace. Competition makes you better, makes you innovate and makes you think of new and better ways to serve your clients.

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