Why landlords should hedge their bets by diversifying their tenant mix
Finding the right tenancy mix can be like walking a tightrope for landlords. Strike a balance, and long, lucrative leases will be the reward. But it only takes a few wobbles to see offices and hip pockets left empty.
Diversity in everything is the key, say agents. A combination of short and long-term leases with varying contract lengths will help keep landlords profitable and protected when economic conditions tighten.
Securing short and long-term leases is ideal, says Richard Fennell, JLL’s head of property and asset management, if expiry dates vary.
“Different lengths of leases, different expiry dates, the ability to allow your tenants to expand, potentially the ability to allow your tenants to contract as well so that you can renew a tenant and give them more space if they need it,” he says.
It can be tempting to relax after securing the tenancy of one large company, but this strategy will come undone should that tenant decide against renewing.
“You want to take a strategic approach to smooth out your income stream as much as you possibly can,” Fennel says.
“Having a building with one tenant, while that can be good in the context of the covenant or whatever, in the context of exposure risk, if they leave, it is better to have more tenants to give you income certainty or some level of income certainty from an investment perspective.”
He points to Australia Square on George Street, Sydney, as a good example.
“It started with big tenants like Lendlease, and then, over time, it got more and more tenants. “That hasn’t meant that it’s got less relevant. In fact, it has a huge community of tenants and tenants wanting to be there within that community and caters to all types of tenants.
“Then, you’ve got the amenity of the ground floor and the retail and all of that. It’s a good example of a well-positioned building that’s gone through that life cycle and has a robust income stream.”
Ultimately, it’s all about finding tenants who pay the rent. Underlying that are happy tenants who are motivated to renew their leases, which hinges on creating a hedge. Some landlords specialise in attracting tenants from one sector to position executives alongside like-minded business brains.
But this can fail should that sector be hit by job losses, so Mark Curtain, CBRE’s head of office leasing for Pacific, suggests targeting a range of tenants from different industries.
“So if you had an oil and gas company in a building and you had a telecommunications company like Telstra – and I’ve seen this play out in reality – where one, the gas company, is growing enormously and the telco’s contracting,” he says.
“The fact that you’ve got that diversification of different sectors makes the two a hedge. So two great companies, but you’ve got a hedge of sectors instead of having two of the same, and that’s important.”
Having a group of tenants under the same roof who all want the same, or at least similar, goals makes life easier for landlords.
This applies to environmental, social and governance (ESG) measures and amenities, Fennell says.
“You want people who are aligned to similar goals – similar ESG [environmental, social, and governance] goals, similar sustainability goals, similar tenant amenity goals and similar activations in the foyer,” he says.
“Now, you can cater for variations there, but the stronger you make the community, and the more welcome they feel, the more likely they are to be happy with their tenancy, and they stay, and that’s good.”
A misalignment of tenants can result in time-consuming mediation and even expensive renovations. Fennel points to government and private enterprise as an example of competing interests.
“Government tenants don’t want flashy foyers with concierges and all those sorts of things because they think that’s probably a little over the top, and it doesn’t look good to be spending taxpayers’ money on that sort of thing,” he explains.
“Whereas if you look at some of the higher-end amenity drivers of tenants, whether it be tech companies or service companies, they want those amenities to attract their employees into the building, so they want more of that front-of-house hotel-type experience.
“But you can get the community aspiration roughly right, and then you make everyone happy, so you’ve got a very productive building.”
Finding the right balance of tenants takes strategy and ongoing maintenance. For a successful financial outcome, the common denominator is diversification among lease lengths and the combination of tenants.
