Leasing costs are typically the largest line item expense for most businesses after payroll costs. Careful and engaged review, and reduction where possible, of these fixed costs are critical to a business’s overall profitability. Getting it right can directly affect the bottom line.
The current economic downturn has resulted in historically high vacancy rates in most markets and submarkets today, and this presents opportunities to improve your bottom line. Landlords are very anxious to both fill vacant space and to ensure continued occupancy of existing tenants. For tenants the upside can be achieved via “blend and extend” (renewal) amendments to their leases that provide for downward adjustment in existing rates, as well as the chance to lock in those better rates for a longer terms going forward.
Resulting improvements in lease costs can go directly to your bottom line.
On the renewal cycle (when you renew your lease) tenants should get started early. Do not wait until it’s too late. By doing so you, the tenant, will lose considerable leverage because there will be no credible threat to landlord that you have other options. You, the tenant, MUST do your homework investigating market comparables, vacancies and viable relocation alternatives.
While most office leases provide for tenant’s renewal notice to be given to landlord no later than nine to twelve months prior to the current end of term, the best period for “blend and extend” negotiations is usually 18-24 months in advance of current lease term end. Obviously, the more credit worthy the tenant, and the longer the successful history of that tenant, the greater its leverage in extracting the best possible renewal terms from its landlord.
The majority of tenants that are not represented by a broker (tenant rep) nearly always end up paying premium rent rates when they could have negotiated discounted rentals and concessions from their landlords.
It is surprising that many tenants that fought hard for the best possible terms when negotiating for their new space are later very lax when it comes to negotiating terms for a renewal.
Worse, in early pre-renewal discussions with their landlords, they convey a sense comfort in staying where they are. Obviously, landlords on the other side of that table then see no utility in “sharpening their pencils” to give these incumbent tenants their best offer on renewal terms.
Landlords and property management will often tell a tenant contemplating the engagement of a tenant rep that getting a broker will actually increase the rental rate for the renewal period – this is a myth. Practical reality is that the market, bona fide comparables, and the tenant’s relative leverage will drive the ultimate renewal rent rate. Again, a landlord’s best possible terms will only be forthcoming if the tenant is credibly examining other alternatives (relocation opportunities). An experienced tenant broker will be instrumental in preparing and informing a tenant’s position in the negotiations.
The initial rental rate a tenant pays for new space is established, in part, on concessions (rental abatements and improvement allowances) given by the landlord to sweeten the deal and make the tenant’s relocation more viable. These concessions are then financed over the initial term of the lease as part of the rent rates paid by the tenant. Tenants are cautioned to avoid allowing those prior rental rates to dictate a scenario where renewal rent rates can only go up from there, especially where the renewal cycle does not include further monetary concessions from the landlord. Additionally, market comparable rates at renewal could be less or more than what the tenant is currently paying at the end of its existing term – thus, a “floor” based on what the tenant is now paying may well have no legitimacy in light of current comparable rates.
Lars Andersen is an independent practice attorney with over 23 years experience in commercial leasing and a wide variety of business entity transactions. He may be reached at 703-349-1251, and via email at [email protected]. Please note that the above article is informational only, and should not be construed as legal advice with respect to your situation or matter – if such advice is required the services of an attorney should be engaged.