How to Plan and Negotiate the Best Terms for your Commercial LeaseAug 11, 2015
5 Tips to Keep in Mind
A commercial lease is one of the easier things to secure in this current economic climate. But just because it’s easy does not mean that you should not take the time to understand how to get the most favorable lease terms for your business.
Compared to the inventory to purchase commercial space, there is more widespread availabilities to lease. As an office tenant, there are a substantial amount of options, as vacancy across the U.S. ranges from 8-20%.
If your business requires a warehouse, it is a tighter market, as vacancy for industrial space is under 10% nationally (and as low as 2-3% ranges in select markets), however there are still more options to lease space than purchasing.
These current market conditions present great opportunities for companies that prefer to lease, as Landlords are competing aggressively for your occupancy.
Whether you plan to renew your lease, consider relocating, or secure a new lease, here are 5 tips you should keep in mind as you begin to plan and negotiate:
1. What Do You Need? (Look Inward)
With so many buildings with signs advertising “Space Available”, you are curious and it's tempting to start your search by looking at what’s going on in the market.
I would suggest, as a great first step, is to understand your current situation in detail. Review and audit your existing lease very carefully. It’s crucial to be aware of the lease provisions that are relevant as your lease expiration approaches.
- Is there an additional cost if you stay in your space past the expiration date? (Holdover)
- Do you have to bring the space back to the condition it was in prior to initially leasing the unit? (Restoration)
- What are your options to extend the lease? (Extension or Renewal Options)
- Do you have the ability to expand your operations, either the unit of space or the building? (Expansion or Zoning)
- Do you have an option to end the lease early? And if so what is the penalty to do so? (Termination Option)
Second, how does your current space work for your business?
Could it be more efficiently laid out? How is the condition? Are there areas to refurbish or redesign? If you know you’d prefer to relocate, what would be the ideal space program?
For your office space, here is a worksheet that will help you begin the process. Give some thought to which departments are adjacent to each other.
Lastly, double check what you are currently paying, including escalations/additional rent and electric charges (more on this below). If you are an industrial or medical user with a triple net (NNN) lease, be clear on the taxes and common charges (CAM).
Now with a better idea of your total occupancy costs, exact lease expiration date, and a rough sense of your space needs (space program), it is a great time to understand how your lease compares to the market.
2. Do Your Homework (Look Outward)
Commercial properties in a certain area or submarket usually are trending in specific ways.
Knowing what you can expect to pay for a particular location, which includes the Landlord concession package (i.e. amount of free rent, improvement allowances, etc.) and recent completed leases in the area, allows you to negotiate from a position of strength.
Additionally, having an idea of what current buildings have sold for recently, who the owners are, their investment criteria and motivation, as well as knowing if any buildings/spaces may be available but not marketed publicly, gives you the best chance to understand where the best opportunities are. The Landlords that “get it” are making substantial capital, amenity, and service level improvements to their buildings which is proving to capture the lion’s share of the tenant market activity.
It is very important to identify what the total occupancy costs are for each alternative. Before any negotiation takes place, be sure to understand the “all-in” costs as asking prices do not always indicate what the total spend may truly be.
For example, the rent structure, in market terms, can vary by geography, property type, and industry sector often displayed as modified gross, full-service gross, Gross plus TE, NNN. For example, medical space is typically listed as triple net (NNN) so it’s very important to understand the additional net costs for taxes, operating expenses/CAM, etc. as well as other important requirements such as parking and electric.
All these factors would need to be taken into consideration so that you can comparatively analyze the market from an “apples-to-apples” financial perspective and develop your options.
3. Create Leverage
The remaining time on your lease or the lead time before you need to occupy space should be used effectively to leverage your tenancy to secure the best possible terms. Knowing your current situation in detail and clearly understanding the options allows you to layout the lease transaction in timeline form. This is a great way to stay on task and know where you are in the process.
Most often, the primary business terms in the lease negotiation with owners and Landlords are:
- Rental Rate- usually stated in annual terms on a per square foot basis.
- Tenant Improvements (TI)- costs to fit-out the Tenant space usually quoted in per square foot terms net of capital improvements or “above the ceiling” costs such as HVAC/mechanical systems
- Lease Term- length of lease, whether the lease is on the shorter side, 3-7 years or longer, 10-15 years.
Rental rate, TI, and lease term all work together to shape the deal and can be adjusted to reflect a win-win scenario for both Tenant and Landlord. This is why knowing your current situation and the market is so important prior to beginning the negotiation process so that it becomes clear what is achievable in getting to acceptable terms for your business.
Another critical aspect that is extremely important to the Landlord is the creditworthiness of the Tenant. Landlords are in the business of stabilizing their assets so they prefer to secure leases with companies that have strong financial positions. Without reference to any other market factors, Tenants with great credit and a solid business history have the ability to secure better terms and concessions.
4. Maximize Flexibility
After you’ve focused on the primary business terms (rental rate, TI, term), think in terms of maximizing flexibility in the lease that will support future changes in your business or the market. Here is a quick list of provisions to address:
- Expansion- could be options on adjacent space, non-contiguous space on the same floor or different floors or the ability to expand the building. In some cases, a contraction option can be negotiated as well.
- Renewal Option- just having the actual option to renew usually is more important that the terms written into the lease because most often, a new negotiation will take place with the Landlord when the times comes to renew.
- Termination- the option to terminate the lease is not a customary provision and will require some negotiating. A termination option may be a good solution to maintain flexibility but offer the Landlord a longer term lease so that they are justified in structuring a lease with more TI, rental concessions and perhaps lower rent. There is usually a penalty associated with a termination option but it may certainly be worth the flexibility of having an option to exit the lease.
- Sublease- always be sure you have the option to sublease your space/building. The Landlord will usually request that the company you sublease to will occupy the building in a similar fashion as to the current tenant mix.
5. Understand Total Occupancy Costs
As the financial decision maker for your company, it’s vital that you know the total costs of your occupancy situation, whether you renew your lease or relocate to another building. We’ve touched upon this above but it’s worth reiterating in more detail. Landlord proposals typically only address the primary real estate terms/costs and it’s important you work with your real estate, construction, and legal advisors to analyze, negotiate, and budget for total occupancy costs. Here is a list of a few items to address:
- Additional Rent- If a gross lease, budget an annual increase to operating expenses (OPEX), CAM charges, and real estate taxes over the base year established in the lease. Use historical expense data to determine a reasonable % increase. Same is true for a net lease, project OPEX and taxes to grow using historical assumptions.
- Electric Charges- electricity is a separate expense from your rental rate and be sure to understand how this paid and what’s included. For example, a “market” expense for electricity for a space on a multi-tenanted floor in a suburban NJ office building is $1.75 per square foot. This cost typically includes electricity for your lights and plugs (the electricity to service the HVAC is included in the base rental rate).
- Parking- in many markets and submarkets (specifically transit hubs), parking may be a separate charge/line item.
- Net Tenant Improvement Costs- when a turnkey construction solution is not possible, be sure to know what your out of pocket costs are for any Tenant Improvements that exceed the Landlord’s contribution. Budget accordingly and pay special attention to “hard” costs which are tangible, construction items that go into the buildout/space/building and “soft” costs, such as but not limited to, architectural, project management, and supervisory fees.
- Relocation Costs- these costs include Moving expenses, IT, telephony, data wiring, and security.
- Furniture, Fixtures, and Equipment- this can be a substantial expense and many options can be considered. New, Used/Pre-owned, Existing and there are many vendor choices. Labor/installation costs must be factored in, which is the main expense when using existing furniture.
The Bottom Line
Meeting the obligations of a commercial lease can be challenging in some situations, especially when your business changes significantly or trends in the market are different than when you last signed your lease. For example, for companies coming close to the expiration of a 10 year lease, we all know the commercial real estate market has been impacted substantially since 2006-2007.
With many of the business, real estate, and legal items in the lease working together as “parts”, it’s vital that you get the negotiation process going on the right foot from the beginning, with ample time to make informed decisions.
As such, it’s to your and your company’s advantage to have an experienced advisor working on your behalf from the start, to save you time and most importantly to level the playing field and create the leverage you need so that you drive the maximum value for your occupancy in the marketplace.
Our team has managed to hone the art and science of commercial lease negotiation. For a no-obligation consultancy, book a call with me on this site. We’d be happy to help.