Most commercial tenants consider leases to be no more than an administrative hassle. But with real estate overhead the second-most expensive line item for businesses, negotiating leases should not be taken casually, particularly for commercial tenants renewing their commitments for an additional five or 10 years.
New terms driven by market conditions and imposed by aggressive landlords can increase a company’s rent and related expenses by more than 50 percent at each renewal. Landlords attempt to impose all costs, risks and inflated profits to their commercial tenants, and most tenants simply sign on the dotted line.
“Why the haste to sign an agreement that is so clearly weighted in favor of the landlord and not the tenant?” says Robert Chavez, founder and CEO of Guardian Commercial Realty. “Dissecting this phenomenon requires an understanding of the dynamics and relevant issues related to negotiating leases.”
Smart Business spoke to Chavez about five insider tips to successfully negotiating with landlords in a commercial or retail lease.
Why do tenants often end up at a disadvantage in lease negotiations?
Most tenants dread the time and costs related to a corporate relocation. Ironically, in their haste to avoid expense and frustration, they often make the most costly mistake when addressing their lease renewals: they fail to leverage their alternatives.
When negotiating lease extensions, tenants focus on the expenses and logistics that impact their company’s direct profits. They pay close attention to their personal costs related to rent, construction, moving, technology, space planning and lost productivity. Though these considerations should be on the list, most tenants fail to recognize the tremendous cost and risk faced by landlords when a tenant vacates a property. This allows landlords greater leverage to charge inflated rates while offering nominal concessions. In exchange for paying higher rent, tenants accept new carpet, minimal rent abatement and a fresh coat of paint as suitable reasons to avoid moving.
How can tenants approach lease renewal more strategically?
1. Quantify the costs faced by the landlord if the tenant vacates. Consider the time the landlord must expend to lease space to a new tenant as well as the improvement costs necessary to retrofit that space.
Construction costs, including space planning and permitting for a modest retrofit, cost conservatively $20 per square foot. Add the cost associated with the landlord’s time preparing, advertising and negotiating a 10,000-square-foot space, and the immediate cost to the landlord becomes apparent and staggering: it typically ranges from $450,000 to $600,000, or $45 to $60 per square foot. Compare this to the $6 to $9 concession package to which most renewing tenants agree.
A commercial space usually does not produce revenue for nine months after a tenant vacates. The key is for tenants to recognize that landlords are always more nervous about the time, money and risk associated with vacant space than they acknowledge.
2. Ignore bullying tactics. Landlords often approach their tenants early and propose two sets of lease terms: the first proposes a lower rate if the tenant is not represented by a broker; the second imposes higher rent for broker-negotiated deals. The landlord blames the extra cost of the latter on commission fees, but the truth is that brokers can negotiate much better terms than either scenario offered by the landlord.
In fact, hiring an experienced tenant’s broker might save more money than employing legal counsel. Though company lawyers understand the law, they are generally not experts in real estate terms and concessions available in a particular marketplace. Hiring both is best.
3. Conduct due diligence. Even for tenants with no desire to relocate, knowledge of the quality, quantity and cost of relocation opportunities provides leverage for the tenant, as does knowing the length of time commercial spaces generally remain vacant.
Understand the true logistics of your space needs. The intricacies of a floor’s layout can be complicated, so use your broker and architect early in the process to assist in determining which building is most efficient for your needs. In many instances, an appropriate floor size and shape can reduce a tenant’s square footage by 10 to 15 percent. Over five years, this translates to an approximate $180,000 savings for a 10,000-square-foot tenant.
Tenants must also exercise care when selecting a commercial real estate broker to represent their interests. Most firms and brokers derive the bulk of their revenue from representing landlords in the managing, leasing, selling and refinancing processes. True tenant brokers will not accept work from landlords, thereby avoiding a conflict of interests and the appearance of impropriety.
Also, be certain that the broker is more than a marketing expert and will be the broker personally handling your assignment.
4. Consider the true cost. Failure to properly negotiate a lease can cost a 10,000-square-foot tenant $300,000 or more over the course of a five-year lease. In addition to the rental rate, tenants should consider items such as square footage calculations, option language for future expansions and extensions, detailed landlord responsibilities, appropriate base year calculations, tax protection and exclusions from operating expenses. These and other issues can cripple a tenant if not properly negotiated, and are often foreign to most tenants who address leases infrequently.
5. Take the initiative. Conducting the due diligence necessary to effectively negotiate leverage takes at least 18 months. The entire process should be finalized no later than six months prior to lease expiration, which means the tenant should start addressing lease negotiations two years before the expiration date.
Be proactive about negotiating your lease and send a clear message to your landlord: you have committed the time, energy and resources necessary to secure the best terms for your commercial office space needs. This is not the only game in town, and your landlord must consider your needs — or another landlord will.
Robert Chavez is the founder and CEO of Guardian Commercial Realty. Reach him at (310) 882-2060 or [email protected]