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Commercial Leasing Is Broken — and Hughes Marino Knows How To Fix It


The commercial real estate leasing market, which took a beating during the pandemic and is still facing a long — and some say impossible — recovery, should have been forced to make pricing reductions and other concessions from 2020 to 2022 in order to lure tenants into leases in what should be a renter’s market. But this didn’t come to pass, and the tenant representation experts at Hughes Marino can explain why.

According to Kastle Systems, a managed security company, anonymized security swipe data from thousands of offices in 10 major cities show an average occupancy rate of 47.6% in November 2022. Meanwhile, office sublease inventory is up from 2020 in every major metro area across the United States and in most markets, breaking records in terms of the supply glut. For example, in San Francisco in mid-November, there is 9.15 million square feet of office space on the market for sublease, and at the end of the third quarter, there were 8.7 million square feet for sublease. At that pace, approximately 100,000 square feet of office space is being dumped on the market for sublease every week in San Francisco right now. (The previous historical precedent was 5 million square feet back at the end of the 2001 “tech wreck.”)

That expected price drop hasn’t happened — yet — in most U.S. office markets. The reason it hasn’t happened is the complex dynamic between the corporate clients that want to lease office space, the landlords who want to rent it, and the brokerage firms, many of which are some of the largest landlords in the nation themselves, that facilitate the transactions.

Hughes Marino co-founder and Senior Executive Vice President David Marino said while there are no easy fixes in making systemic change, his firm has taken a tenant-centric approach it feels can help tenants avoid what amounts to a degree of collusion and price fixing between competing landlords when it comes to rental pricing.

Hughes Marino Exec Reflects on a Broken System

David Marino has been in the real estate game for over 30 years and has seen a variety of market cycles come and go.

This current cycle is fueled by pandemic-mandated office closures in much of the country during 2020 and 2021. While past recessions like the tech wreck and the 2007-2008 mortgage crisis saw waves of business closures and, therefore, extensive commercial lease defaults, the U.S. government’s backstopping of the economy through Payroll Protection Program loans and sending checks to consumers during COVID created a condition where most office tenants continued to stay in business and paid their rent as those government PPP loans allowed for payment of rents out of the loan proceeds.

In 2022, the slow and uneven “return to the office” is unique this time around. That inconsistent return has produced some markets with a lot of space available, and a lot of subleases being put on the market as corporations try to recover what they can from office rentals they don’t need at this point.

“This inventory is coming on the market at an accelerated rate now in 2022, as more and more companies attempt to rationalize their real estate footprint needs. Some people really want to come back for mentoring, communication, culture, or because they don’t have appropriate home office environments, yet others are never coming back to the office,” Marino said. “And another bulk group of people, ranging from 20% to 50%, are only coming back a few days a week or month, using a hybrid office share. Companies just don’t need as much space as they used to, given the broad change to remote working and hybrid models.”

This, Marino said, has led to a situation where corporations and businesses, through their dumping of high-quality plug-and-play spaces for sublease, have now become their own default competition to landlords in filling offices.

“Tenants just want to cut the burn rate,” explained the Hughes Marino executive. “They just want to get some kind of economic recovery. If they get 50 cents on the dollar, they get 70 cents on the dollar, well, that’s better than losing the dollar.”

This act, while a smart play for the businesses, “erodes any kind of pricing power” the landlords have, Marino said. That’s where some questionable behavior comes into play on behalf of the landlords.

“This has been really a strange dynamic,” Marino said. “People will ask me, ‘Well, David, how can these landlords still be asking the same price as they were pre-COVID two-and-a-half years ago, yet the market’s a lot worse?’ And I say, ‘Look, you’ve got to realize that lowering prices doesn’t create demand.’

“The reality is landlords try to maintain their economics,” he said. “As one real estate developer told me a number of years ago, ‘Hey, I’m in the last great unregulated industry.’ The truth is commercial real estate is completely unregulated. And landlords share information, and use the brokerage community as a fluid source of information to make sure everyone stays in lockstep. Landlords talk and cooperate because they can, and it’s in their mutual interest. No one on the ownership side wants to see a price war, as it drags them all down.”

While perhaps more exposed now post-pandemic, this sort of behavior by landlords has been cited before.

Hughes Marino Sr. EVP David Marino on Landlords Working Together

Marino wouldn’t go as far as to say that what some landlords were doing was collusion, but at least one legal matter has made the declaration. In a lawsuit filed in the Southern District of California in October 2022, a group of renters accused nine large landlords of using third-party pricing software as a way to collude and keep rents artificially high.

Texas-based RealPage, a software development company that created an algorithm called YieldStar, was the conduit for the landlords. The software takes real-time availability of rental inventory and compares the pricing in neighboring buildings and areas to suggest an ideal price for the landlords: not too high to price them out of the market, but not too low.

While the landlords were under no obligation to use the algorithm’s suggested rates, the company “encourages” them to do so. The lawsuit mentions that the company advertises that it can “drive rental rate improvements, every year, between 5% and 12% in every market.” If every landlord in an area does this, as is alleged in the suit, it allows for an artificially high floor price.

The suit also claims that RealPage’s information on available inventory allows for landlords, working together, to keep an optimum number of properties vacant at any given time to avoid oversupply and thus increase prices, even in markets that clearly should have been battered by the pandemic.

Marino said landlords could work against each other, lowering terms to gain somewhat of an advantage over their competitors, but that would damage the market as a whole.

“So the landlords all work together to keep a floor on asking rates,” Marino said. “And I guarantee you, they talk. When COVID hit in 2020, the first thing that happened was all the landlords got on the phone and said, ‘What are you going to do? Are you going to lower prices?’ And people are like, ‘No, no, no. We’re not lowering prices.’”

Marino said there are certain markets (such as those where Hughes Marino has set up shop) that house life science and biotech hubs, like Boston, San Francisco, and the Raleigh-Durham area in North Carolina, that are “back” — but for the most part, the narrative the landlords are trying to float to clients is fiction.

“So when you read the landlords and their brokers’ promotional information, you get this narrative that, well, maybe things aren’t that bad,” Marino said. “And maybe they’re really coming back. Because they’ll give you some examples of something that feeds their storyline, but the reality is that it’s not going that great for these guys.”

How Brokers Factor Into the Equation

While the landlords drive the price increases, as Marino mentions above, the act doesn’t work without the brokers playing along.

Marino said most brokers don’t go into a deal with the intention of doing something that, while legal, is morally questionable. But he pointed out that the financial incentives to do so can make even the stoutest-of-heart brokers reconsider their position.

“The problem is when you have the opportunity to make hundreds of thousands of dollars more money because you put a tenant in a listing of yours where you get both sides of the fee, the economic incentives are just too strong for even the most ethical, good person to overlook,” he said. “You’re always going to give your landlord client a last look.”

He added that the end result is often not just higher prices for tenants but also longer-term leases, which are usually not in the best interest of the tenant but certainly serve as a financial windfall for both landlord and broker.

He said that signing a tenant to a new, longer lease instead of a sublease, for example, could increase the commission to the brokers from 40% to as much as double that. But those long leases, especially for tenants that have more fluid business models or are particularly susceptible to market conditions, are certainly not in the best interests of the tenant.

Rocking the Boat

Marino said Hughes Marino is now in five states with nine offices, making it truly a national player. But the way Hughes Marino goes about its business, with a tenant-centric focus and emphasizing transparency, confidentiality, and independence, has not necessarily been greeted with celebration by competition in those markets.

“People see what we’re doing,” Marino said of Hughes Marino’s competitors. “People are talking about what we’re doing. Competitors are nervous and anxious about the moves we’re making.” Hughes Marino is also recruiting some of the top tenant representation talent away from local firms in each market as they expand, and the big brokerage firms don’t like it.

He said the traditional brokerages “don’t love what we do as we draw the conflicts out into the bright light of day,” and the fact that Marino and Hughes Marino are calling out the conflicts of interest that exist between landlords and their brokers has made the market somewhat afraid of what the results of their success could be.

But it seems they may have to make their peace with it, as Marino says there’s an advantage to be gained from advocating for the tenants.

“It’s something that our competition doesn’t really want to hear about,” he said. “Frankly, if you are competing for tenant business, it is a competitive advantage to represent tenants and it has become a niche specialty. If you need brain surgery, you don’t go to a general practitioner.”

Marino said Hughes Marino’s approach isn’t complicated, just deliberate.

“Frankly,” Marino added, “a lot of landlords like how we approach the process as it’s always a fair fight, and we aren’t trying to give the tenant a particular outcome, but rather the solution that is best for the tenant. We also do a lot of lease renewals, and we have no financial incentive to move a tenant unless the current landlord cannot accommodate the requirement or be competitive.”

Marino said, “We’re just thinking about being good listeners. Let’s ask great questions. And then let’s go to the market to uncover all of the alternatives and create a robust negotiation and create an auction environment for that tenant and their credit and their size to get the best deal for the tenant.”

Marino said that the fact that landlords, collusion or not, communicate and, for the most part, corporate clients do not, they are set up to lose.

“It’s not like corporate America is organized around their leasing,” he said. “There’s no lobbyists. Meanwhile, landlords are incredibly organized.” Even the commercial real estate trade groups are set up to serve landlords in the industry, like the Building Owners and Managers Association and Building Industry Association. There’s no organized trade group looking out after the tenant.

Marino said his shop’s approach of focusing on the tenant is a differentiator in the market.

“The landlords and the brokerage community have all the power,” Marino said. “That is why we are building what we are building. We think we can be the changemaker in our industry. We think we can build something that is enduring, that is independent, and that matters. That will always be here to serve the business owners, management team, and board of directors that make up the tenants.”

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