Recently, after participating as a speaker at a Real Estate Investment forum hosted in Panama by NAI Panama, several local office developers were curious to get my thoughts about the 69% increase in the Panama office inventory that is coming on-line over the next two to three years and how that will affect Contract Rent Rates.

The main concern was how low I thought the rents would go. Having survived the USA’s S&L crisis of the late 90’s and the Mexican peso crisis in 1985, and witnessed the massive overbuilding that occurred in Mexico City (particularly in Santa Fe) in the early 2000’s, I felt acutely prepared to read their collective crystal ball. I responded, of course, that I am not a clairvoyant; however, based on my past experience rents would probably drop about 15% to 25% depending upon an office building’s leasing demand. This is what I saw happen in Mexico City’s Santa Fe submarket. This news was unpleasant enough for my anxious audience, but they were further displeased to hear what else the Mexican landlords had done to successfully lease their buildings.

As the competition tightened and the office vacancy rate climbed above 14%, some lessors began to provide some of the TI’s that may be considered core items and that could be used by any future occupants of the same premises, such as the main fire sprinkler ring, main HVAC ducting, some key VAV boxes, primary electrical to the floor, etc.  (For novitiates to Latin America & the Caribbean, tenants have to provide and pay for their own tenant improvement build-out - 100% of it – unlike in the USA where landlords provide a TI allowance that allows for a vanilla build-out.)

As the vacancy rate climbed above 19%, a few landlords began to offer to amortize the cost of the tenant improvement build-out – effectively upping the competitive ante between buildings. (Nota bene – This is still offered in Mexico City and has become relatively standard for the largest, most successful office buildings, but it does not occur anywhere else in the region ….yet.)

The more agile and well-capitalized landlords eventually realized that it is not just the face rent rate that matters for companies, but, in reality, the aggregate cost of occupancy. When this light bulb went on, some began to play mix and match with the occupancy cost variables, for example offering a lower contract rate, some TI concessions and, perhaps, even amortizing all or a portion of the TI costs.

For the US office market expert, the question would probably arise, “What about free rent? The landlords could simply offer free rent …and tons of it, if necessary.” That is not likely. Contrary to the US market, free rent a la US-style is not offered in Latin America. Tenants in the region are fortunate to receive three month grace period just for the tenant improvement build-out, and in secondary and tertiary submarkets they may only get two. In the USA the contract occupancy term does not begin until the TI construction period is concluded or the pre-negotiated construction period expires (usually three months), whichever occurs first.

However, in Latin America & the Caribbean, occupancy contractually starts once the lease contract is duly signed between and delivered to the participating parties. On an additional note, during the TI construction period, tenants in Latin America & the Caribbean also pay for all utilities and the CAM for the leased premises starting upon the effective contract execution date; unlike the USA where these expenses are largely absorbed by the landlord until the tenant takes possession of the improved premises.

All the previous being said, as it pertains to the Panama office sector, if demand does not increase significantly over the next two years, I may recommend to the landlords that they see the 60’s Hitchcock movie The Man Who Knew Too Much and learn to sing-along with Doris Day, “Qué será será….”