2014 Commercial Space Guide

In the hunt for commercial space, local landlords are beginning to realize that the financial decline of 2008-09 has bottomed out and the market is gradually returning to a state of equilibrium where neither landlords nor tenants have a distinct advantage. Still, there are a few clouds overhead as businesses consider lease renewals and try to determine if their existing space still works for them.

With an economy that contracted in the first quarter yet saw improving job numbers in the second, there is room for doubt about where we’re headed, especially with so many companies still holding onto their cash.

“I don’t think anybody can figure that out anymore,” said Michael Brusca, a senior broker with Newmark Grubb Gialamas in Madison. “The normal indicators in the past that affected these decisions don’t seem to apply anymore. When I talk to investment firms, people that manage money, it’s hard to predict.”

Amid this lingering uncertainty, we present a dozen topics, including some best practice advice, that local businesses need to know about in their search for commercial space — everything from landlord and tenant etiquette to some of the new office trends that have made their way to Greater Madison, to the purported advantages of the office condominium.

We also explore the the difference between paying your lease on a triple-net or gross basis, and we present the highlights of the latest quarterly Madison market report from Xceligent. — Joe Vanden Plas

Wanted … Good Landlords

So what makes a good landlord? It comes down to the ability to stay on top of things, which requires the help of tenants, according to Michael Brusca, senior broker for Newmark Grubb Gialamas. Brusca says the best landlord-tenant relationships are win-win, not win-lose or vice versa. Here’s how landlords can make that relationship a win-win reality.

1. Maintain good communication with tenants, property management firms, and listing brokers.
2. Have a clear understanding of current market conditions.
3. Monitor and keep in touch with tenants.
4. Walk the property occasionally to make sure your property management firm is living up to expectations.
5. Keep on top of deferred maintenance.
6. Keep an eye on your tenants to ensure they are not outgrowing their space; you do not want to address this after they have already decided to move on.
7. Make sure the listing broker is giving you progress reports.
8. Choose a competent broker who will work your property and is not just interested in listings or his or her own self-interest.
9. Make sure someone is monitoring whether a tenant is in trouble business-wise.
10. Have a good understanding of the intentions of tenant representatives.
11. Understand and be prepared to participate in potential tenant build-outs.
12. Keep excellent financials.
13. Make sure potential tenant business does not compromise existing tenants. “It’s very important, especially today, to conduct due diligence when considering a potential tenant,” Brusca added. “You do not want to compromise to fill your building. That could backfire in the future. I’ve seen cases where you put a tenant in that’s completely different and tenants in the future end up moving out. As a broker, you need to negotiate the best deal, but you also have to understand both sides — both the landlord’s perspective and the tenant’s perspective.”

… and Good Tenants

The advice above pertains to what makes a good landlord (something every tenant should know), but what makes a good tenant? Good tenants have a number of common traits, according to industry executives, and they also avoid common mistakes in this marriage between property owners and occupants. Annette Gelbach of Key Commercial Real Estate in Madison offers the following basic advice:

1. Treat the property with respect, like you own it (pride in ownership).
2. Treat the landlord with respect.
3. Pay rent on time.
4. Report maintenance issues.
5. Follow rules and regulations (read and understand your lease agreement).
6. Communicate with the landlord as issues arise, not after letting those issues grow out of control (no surprises).

Tim Rikkers, a principal with Cresa Madison, says the landlord-tenant relationship is most affected by the lease agreement, and he agrees that it must be a win-win proposition. From the tenant’s perspective, it’s imperative to negotiate a lease that secures the premises for a defined period of time, offers the flexibility to adapt to changing business conditions, and provides cost certainty for the sake of business planning and budgeting.
In a perfect world, a tenant could put a lease in a drawer and forget about it, but that’s not the way this relationship works. “Landlords have budgets and mortgages to pay, and tenants must be able to budget for their costs and their expenses,” Rikkers noted. “With any luck, a lease will provide a measure of cost certainty so that both sides can budget for unexpected mayhem.”

Targeting the Best Space

When it comes to commercial space, “It is only a ‘good buy’ if it’s a property that works for you, your employees, and customers,” says Annette Gelbach of Key Commercial Real Estate.

And good buys can be found in just about any Madison submarket, whether it’s downtown, near west, far west, south, or east.

To help you lock in the best space for your company, experts advise:

Understand what works for your organization. For example, an older building or a property with low visibility may offer low rents, but they may not be the best value for your organization if clients can’t find you or employee morale is low due to the lack of amenities.

Focus on financially strong landlords. Landlords with stronger financials are able to offer more incentives to tenants in trade for a longer lease term.

Find a market that serves your niche. Municipalities have a number of tools (incentives) at their disposal to attract commercial tenants and stimulate economic development, from land to low-interest loans to tax increment financing to job-creation grants. They use these tools for different ends.

A few examples: The City of Middleton offers incentives for large users, such as Spectrum Brands, to occupy available space. Cottage Grove, which is served by several major highways, looks to lure industrial users. Fitchburg, the home of Promega Corp., promotes itself as a shovel-ready city, especially for high-tech and biotech users. Sun Prairie, at the convergences of Hwys. 151 and 90/94, has attracted retailers like Cabela’s and Target. It is positioning itself to be a regional retail hub, with very competitive utility rates.

“Generally speaking, smaller tenants don’t pursue those incentives because they are hard to get,” noted Tim Rikkers of Cresa Madison. “But if you’re a large manufacturer, you’re creating a lot of jobs, and you’re making a long-term commitment, sometimes the investments bring a good return.”

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Vacancy Rates Declining

In the past year, vacancy rates have dropped in the Madison office, industrial, and retail markets, with steeper declines in the latter two classifications, according to the recent (Q2) Market Trends report from Xceligent. The chart below quantifies the respective declines in vacancy, and the report links higher occupancy to corresponding increases in the absorption of space in office (+200,000 square feet), industrial (+1.1 million square feet), and retail (+561,428 square feet).

Madison's Ongoing Tiff Over TIF

If you thought the City of Madison’s new tax increment financing policy would end all controversy, you were wrong. The new policy was applauded in many circles as a boon for economic development, and it still promises to turn out that way, but early experience shows there are still some issues to work through.

What’s all the fuss about? Carole Schaeffer, president of Schaeffer Consulting and executive director of Smart Growth Madison, noted that one of the biggest changes in city

TIF policy was a measure to allow speculative TIDs, or tax increment districts, to be created. For years, developers had complained the city was losing business to suburbs because it had no existing TIDs, and so the ’burbs were able to be more nimble in terms of offering a loan to a business, without having to wait months for a state sign-off on the creation of a TID.

Under the new TIF policy, the City of Madison is allowed to create up to two speculative TIDS that can run simultaneously, but there is disagreement about where to put them. As the city staff takes inventory on possible sites, some are calling for them to be established on the city’s perimeter, particularly the west side, while others want them downtown.

According to Schaeffer, perimeter developers say, “Look, there are already a lot of TIF districts downtown. They are already competing with us because they are able to get at a lot of resources, and land is more expensive downtown.”

“It will be very interesting,” Schaeffer added, “when these things actually start coming in.”

Brighter news comes with the elimination of the so-called equity-participation payment, aka the “equity kicker,” which added millions to the cost of a TIF development and therefore created a significant disincentive. “I think that’s going to have an immediate impact for folks who are signing development agreements with the city,” Schaeffer stated.

Lease Renewals: Should I Stay or Should I Go?

When your lease is set to expire, does that necessarily mean you need a new lease on office life? It might, but some number-crunching due diligence is required before it’s splitsville between you and your landlord.

The work should begin about one year — or six months at the very least — before your lease is set to expire.

Landlords have the option of working through a property manager, especially if they lack the necessary market sophistication, and tenants typically work through a tenant representative. Both parties seek outside help because it’s important to understand current market conditions. “Knowing the current market conditions is the best way to negotiate terms, whether you decide to stay in your current location or decide to relocate,” noted Annette Gelbach of Key Commercial Real Estate.

Since the decision often boils down to economics, market information is needed to compare your current space to alternative locations and to understand the strength of your negotiating position when negotiating for lower rental rates, incentives for free rent, and tenant-improvement allowance — to name a few of the areas where tenants can save money, Gelbach said.

As tenants look at relocation options, they should factor in the cost of a move and then make a business decision. “First of all, [factor in] moving expenses,” added Tim Rikkers of Cresa Madison. “Unless the space you’re in cannot accommodate your business anymore, a renewal is always a key consideration.

“Generally speaking, what a tenant rep would do is get a renewal proposal from the landlord, get relocation proposals from competing landlords, and compare them side by side.”

The key metric, according to both Gelbach and Rikkers, is total cost of occupancy for each alternative. Tenants might be moving from a building where they are paying for parking to a building where they are not, or vice versa. The tenant might be able to negotiate significant free rent from a landlord when relocating, which would then drop the cost.

It’s also possible for tenants to negotiate space flexibility regarding expansion rights, the right to sublease, or the right of first refusal, which relates to taking adjacent space in the building, but dollars and cents are the key consideration. Said Rikkers: “At the end of the day, what does it cost for you to occupy that space?”

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Work Spaces for Millennials

In terms of eclectic, youth-oriented office space, is Madison becoming Funky Town? With regard to business environments with an off-the-charts coolness factor, Madison lags a bit behind some major cities, but with its interest in building a stronger information technology sector, the city is trying to catch up fast.

The characteristics of these funkier work spaces include a lack of ceilings, exposed ductwork, wood or cement floors, and often an “open” or more collaborative space. Those features are well aligned with modern office design, but when you sprinkle in gathering areas that look like living rooms, with large-monitor television sets used as tools in collaborative meetings, you have the basis for a futuristic work environment.

At EatStreet, 131 W. Wilson St. in Madison, an open floor plan with work tables creates a collaborative environment.

“The spaces are in both traditional office buildings and in buildings that are unique throughout,” noted Annette Gelbach of Key Commercial Real Estate.

These kinds of spaces tend to cluster in downtown Madison and the isthmus, further ratcheting down the vacancy rate of the downtown submarket. Unique spaces exist at the Sector 67 innovation space, 100 State (and other co-working spaces), and 131 W. Wilson St., where startups like EatStreet have set up shop. The recently approved Archipelago Village, to be developed on the former Mautz Paint property on East Washington Avenue, promises more flexible and co-working space for entrepreneurs.

Many of the area’s young entrepreneurs are former Epic employees, and some of them, at a very young age, are trying to build multiple companies. “What you have seen downtown recently, especially on Capitol Square, is a tremendous amount of startup activity, especially in the IT and health care software sector,” noted Tim Rikkers of Cresa Madison. “There are a bunch of 25-year-old entrepreneurs who are looking for open, collaborative, funky, and cool space.”

According to Rikkers, many of these companies are signing short-term leases, for a couple of reasons: First, they have very uncertain growth models and, second, they are not typically well capitalized so they aren’t able to secure long-term leases that would provide for things like tenant improvements. “So they occupy space that is second- and third-generation space, using long tables, card tables, used furniture,” he says, “but the amount of energy they are injecting into the downtown is fantastic. It’s changing the dynamic of the downtown office market.”

Renters' Market Fading in Rearview Mirror

In 2009, at the height of the Great Recession, it was a great time to be a tenant in the commercial office market — if you were one of the survivors. Landlords were losing tenants left and right, and while it’s not accurate to say they were willing to do anything to stop the bleeding, they were more open to lease concessions than ever before.

As the economy has gradually improved, the commercial space market has inched closer to equilibrium, where neither side has the upper hand. “The rental market has tightened up in the past year,” said Annette Gelbach of Key Commercial Real Estate. “Rents have increased, and the incentives to the tenant from the landlord — such as amount of free rent and improvements to the space paid by the landlord — have decreased.”

Gelbach says certain sectors of the market, such as State Street, have rebounded even more than most, while Class C office space has not rebounded. “I would classify it as very close to equilibrium [overall],” she added.

Tim Rikkers (Cresa Madison) concurred. “I think we’re closer to an equilibrium, where it’s healthy for all parties,” he said. “You’ll find there are landlords that are eager to recapture the losses they sustained, and I don’t blame them.”

However, in most Madison geographic submarkets and in most industry segments, there still are more available spaces than there are tenants, says Rikkers. “There are a couple of segments that are very, very tight,” he stated. “In Madison, the industrial market is very, very tight. There are a few large lots of space — 40,000 square feet and above. If a tenant wanted to go out and understand how many options there are on the west side, there are about three of them, so there are certain segments of the market that are tighter than others.”

Michael Brusca (Newmark Grubb Gialamas) agreed that the market is approaching equilibrium, noting that both tenants and landlords are starting to realize the financial decline of 2008-09 has bottomed out. That means landlords will be able to raise rents and lower concessions. “Vacancies and rates seem to have stabilized, and some industries and submarkets are better than others,” he said. “One single large transaction can make a large impact on the numbers.

“It appears to be very active. I’m not seeing as many unrealistic tenant-rep proposals as there were a couple of years ago.”

In the office market, Brusca sees tenants moving around a lot within their own buildings as businesses either expand or downsize. “Class A has been doing real well,” he added. “I think the future is bright for everybody. When the market is active, brokers are busy, landlords are doing deals, and as I said, the cycle is turning.” 

Historic Preservation: Giving Old a New Use

Historic preservation and adaptive reuse restored the old city train station at 660 W. Washington Ave. Photo courtesy of Alexander Co.

Historic preservation has been called the ultimate form of recycling, but there is much to know if you want to secure a historic designation for a residential or commercial building, if your neighborhood has a special historic character worth preserving, or if you want to add to or establish a historic district like Mansion Hill or University Heights.

What’s Historic?

According to architect Arlan Kay of Architecture Network, these features make a building truly historic (not just old):  

It’s on an archaeological site.

The building is the location of a significant event or is identified with a significant person.

It’s a unique example of architecture, period, or style (it can be a district consisting of many buildings; the group may be significant even if the individuals are not).
It was designed by a famous architect.

Processing everything

The official process begins by making an application to the city planning division. The applications, which are considered by the Madison Landmarks Commission, are available online at cityofmadison.com/planning/documents/
LandmarkApplication.pdf.

Also on the city planning website are various dates when applications can be considered, depending on whether a public hearing is required. Submittal dates are available at cityofmadison.com/planning/documents/LandmarksDates.pdf.

The city contact is Amy Scanlon at 608-266-6552 or ascanlon@cityofmadison.com.

Partner Up

You’re not alone in your quest to make a contribution to historic enrichment. The Madison Trust for Historic Preservation (madisonpreservation.org) was established in 1974 after two historic homes were demolished in the name of urban renewal. One of its activities, in addition to working closely with the Landmarks Commission, is to assist other organizations with preservation efforts.

Financial Help

There have long been federal tax credits for historic preservation, but now the state of Wisconsin has piggybacked that with a larger tax incentive of its own, leading to a larger-than-expected boost in construction activity.

The federal historic tax credit is based on 20% of the eligible construction costs of adaptively reusing a building, and it generally allows developers to bring a partner into the deal. “Usually, it’s a large corporation,” noted Joe Alexander, president of the Alexander Co., which has been involved in a number of historic renovation projects. “They want the tax credit or have the tax liability to use it, so they will purchase those credits, and the proceeds of their purchase will benefit the project and help pay for construction.”

At the state level, the Legislature passed and Gov. Scott Walker signed into law an increase in the state’s historic tax credit from 5% to 20%, bringing Wisconsin in line with most surrounding states. When the law was signed late last year, the state expected roughly $4 million in state credits to be awarded, but from Jan. 1 through June 23, the state approved $35 million in state historic tax credits. “The state, by offering this $35 million in tax credits, has now leveraged $175 million in construction projects,” Alexander says.

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Salute the Telecommute

Yahoo CEO Marissa Mayer might have stirred controversy with her decision to order telecommuters back to the office, but it underscored the notion that telecommuting might not be the best workforce policy for companies that require innovation, which requires human collaboration, which requires employees to be present in the office environment.

The telecommuting office of Alan Sanderfoot, In Business magazine’s creative director and associate publisher.

Still, the ability to telecommute can give employees an opportunity to do head-down work, not to mention curtail what families spend on transportation, so the technology-enabled trend definitely has its place. Roughly one-fourth of employed Americans work from home for at least a few hours each week, according to the Bureau of Labor Statistics, and the federal government would like their ranks to exceed 50% over the next several years.

Companies that want to enable trusted employees — this is a case-by-case decision — to work from home should establish some guidelines. With the help of TDS Telecom, the QTI Group, and InteriorLOGIC Facility Planning, we provide the following tips for managing the telecommute.

1. Establish requirements for employees who are approved for working at home. The requirements might include a minimum of one year of service, full-time status, and a clean disciplinary record.
2. Note that teleworking is considered an employee benefit and is subject to wage-and-hour-law provisions, including overtime.
3. Secure technology must be used to connect to your office network. As for the necessary equipment, the same criteria used in the corporate environment — flexibility, adjustability, mobility, and wireless — are also the basis of the home office. Also, work-at-home employees must be able to safeguard company equipment from non-company employees to prevent unauthorized access, theft, or other damage.
4. The same National Labor Relations Board edicts about protected concerted activity — which protect communications about working conditions even if they are derogatory toward management and even if they are tweeted out into cyberspace — must be adhered to for telecommuters.
5. Make sure each telecommuting employee has a private, quiet space to work in and an ergonomically sound desk and chair.

Is Triple Net Really Gross?

When negotiating a commercial lease, there are three types of arrangements between a landlord and a tenant: full-service gross, modified gross, and triple net. So what’s the difference?

According to Cresa Madison, the differences between the three pertain to how, and by whom, the “triple-net” costs — taxes, insurance, and common-area maintenance — are dealt with. Since all three are prevalent in the Greater Madison market, here are the basic elements, and the advantages and disadvantages, of each:

So Gross

In a full-service-gross lease, triple-net costs and additional costs such as utilities and janitorial (but excluding the costs of phone and data) are bundled into the base rent. So-called “FSG” leases provide tenants with the highest level of certainty regarding their complete occupancy costs, but the downside of an FSG lease is that an annual escalator increases the base rate of the lease, regardless of any real fluctuations in operating expenses.

The MG

Modified-gross leases typically include all the triple-net costs, except for utilities and/or janitorial service, but they have advantages and disadvantages that are similar to those of an FSG lease in that taxes, insurance, and common-area maintenance typically are bundled into the base lease rate. A distinct disadvantage of MGs is that utilities and janitorial services are two additional variable costs for tenants to consider, so it’s important to note that an MG lease can be modified to include or exclude any individual expense within the base-rate bundle.

NNNet Gain

In a triple-net, or NNN lease, the tenant is responsible for the pro-rated share of the triple-net costs (taxes, insurance, and common area maintenance) and for utilities and janitorial services. The key advantage to this type of lease is transparency in that all of the building’s operating costs are available for the tenant’s review. The main disadvantage is that triple-net costs are not guaranteed in the lease and are subject to increase or decrease — usually increase.

The Case for Office Condos

The Great Recession brought about many changes in commercial real estate, and five years out from that soul-crushing period, real estate executive Dan Roseliep is just finding renewed interest in the commercial condominium concept.

Office condos are located throughout Dane County, including this facility on Horizon Drive in Verona. Photos courtesy of ALTUS Commercial Real Estate.

Roseliep, managing director-owner of ALTUS Commercial Real Estate (formerly Sperry Van Ness), already manages a number of commercial condos, and his firm might add more to its portfolio. “It’s very difficult for small businesses to find a stand-alone building that’s the right size,” he explained, “but you can find a condominium space because there are pieces of the building that are just the right size.”

Condo offices have several defining characteristics, including:

Owning Your Space

The term condominium refers to a form of legal ownership. “It has to do with owning a piece or unit of the building, rather than the whole building,” Roseliep says. “The condominium concept can be applied to most forms of real estate. In the commercial world, that would include office, industrial, or retail.”
Office condos usually have bylaws that define how they are governed, and most condominiums have professional management, which makes it easier to own your asset.

“You don’t have to self-manage, and it’s part of your dues, it maintains your investment, and it allows you to buy building services and labor very efficiently because you are part of a larger group,” Roseliep said.

Pay Model

In an office condo arrangement, a company pays for the expenses on its unit and also a pro-rata share for the common elements based on its interest in the whole. In a 10,000-square-foot building divided into four 2,500-square-foot office spaces, each occupant is the owner of its space and contributes 25% of the cost of maintaining the whole 10,000-square-foot building. That includes things like parking lot maintenance, landscaping, and snow removal. Insurance is usually common on the structure, and a reserve fund allows the condo association to maintain the asset by allocating a portion of monthly dues to cover the cost of major capital improvements.

Appreciation Day

In the long run, owning a commercial condo can be preferable to leasing. According to Roseliep, businesses that own their own office can build equity over time and enjoy the advantages of appreciation. In addition, condo owners can construe interest expense as a business expense and write off real estate taxes.

Condo offices, whether new construction or rehabbed buildings, can be found throughout Dane County, and Roseliep believes there will be more of them because “they remain an efficient way to own office space, retail space, or industrial space.”

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Collaborative Office Designs

As a result of people’s desire for more interaction, collaboration, and innovation, Robin Stroebel is seeing smaller spaces, and as the CEO of InteriorLogic Facility Planning, she’s okay with that.

Collaborative office designs are increasingly popular, as shown in these new spaces for (clockwise from left) Connecture’s office and cafe and Access Wisconsin’s cafe.

Especially because the trend she’s seen in Chicago and other large cities has hit Madison with full force. “The idea that you’re going to be more in an open environment yet have the ability to have private space when you need it, the trend was there, but now it’s actively being pursued, not only by folks in the C-suite but by the staff itself,” she noted.

Whether it’s health care, research, or software development, organizations want to innovate, be forward-thinking, and to some degree have their people overhear what others are saying — anything to spark an idea. The recession and its resulting business shrinkage played a role, but the desire for collaborative work space is primarily driven by the way young people want to work; older workers, having realized what they’ve been missing, have willingly come along for the ride.

“Those work spaces were shown to be more effective rather than trendy,” Stroebel noted. “For a while, it was just trendy to do it. Now, it’s really integrated into the fiber of planning, not just for the real estate businesses but for the benefits that it offers for innovation and flexibility and mobility.”

All of this is augmented by wireless Internet, which prevents people from being pinned down as they stroll open territory with iPhones and iPads. With the office fast becoming a space of diversity, the following components might be coming to an office near you:

Collaborative Cool

Collaborative lounges, coffee bars, and multi-use cafes are gradually replacing traditional conference spaces and providing the “coolness factor” innovation-minded companies need if they are going to curtail employee-friendly trends like telecommuting. “You’ve got a choice of spaces for the way that you want to work during the day,” Stroebel noted. “I think that’s appealing to all age groups.”

Enter the enclave

Yes, there are more wide-open spaces, but people still need more compact spaces for those times when they want to escape “time bandits,” whether they be people or technology, and complete some head-down work. “As long as you’ve got that private space, as long as you’ve got that space to meet with your co-workers for more formal or informal meetings, then you’ve got that space where you’re all meeting together and sharing ideas,” Stroebel said. “It’s the way people live, if you will, in the office these days with that diversity of space.”

The train gain

More organizations are taking it upon themselves to conduct internal training, which requires technologically well-appointed spaces that augment the company brand. “That’s part of that environment of ‘let’s bring people in, let’s keep people.’ … We’ve got the facilities, let’s use them.”

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