Business leases are one of the most
important contracts a company will
sign. They set out the obligations and rights that will govern tenancy for a substantial time period.
A poorly negotiated lease may result in
inconvenience, financial hardship and a
disruption of your business. At worst, you
could be held captive by a lease if you
haven’t carefully negotiated every facet of
your tenancy, starting with the rate calculation.
“When shopping for office space and the
landlord tells you he is asking $4 per square
foot for the space — after you recover —
you feel pretty good when the rate ends up
being settled at $3.20 per square foot,” says
Jason Hughes of Irving Hughes in San
Diego. “It’s not every day that you can
negotiate a 20 percent savings, so you may
feel satisfied with the final number. But
what about those ‘something extra’ costs
that surface later?”
Smart Business spoke with Hughes
about the psychology of landlord negotiations and the importance of professional
representation when hammering out a
business lease.
How have lease negotiations tipped in favor
of landlords?
Five years ago, a landlord hoped to rent
out his building for $2 per square foot —
and would have given a tenant six months
of free rent and a lot of money to improve
the space — yet now that same landlord
wants $3.50 per square foot with no free
rent and half of the improvement money.
The economics are nearly three times as
good for the landlord, or one-third as good
for the tenant.
Where does the psychology come into play?
It can be mentally satisfying when you
buy something at a deep discount. Getting
a deal is one of the pleasures in life. But
some landlord markups are done with the
sole intention of ending up at the ‘discounted’ rent price. Should that make you
feel good?
Let’s say the landlord is asking $4 per square foot for a space and settles at $3.20
per square foot. Do you feel less taken? Or
think of it another way: Would you feel better if most of the other properties nearby
were asking for the same rate?
Doing business with respectable people
who are problem solvers rather than problem makers is worth a premium. But what
if you’re paying premium for a problem
maker who also provides poor property
management and packs operating expense
pass-throughs to their tenants with season
passes to the Padres and Chargers as well
as cases of wine and Cuban cigars?
What is the basis for the landlords’ rent calculations?
While most people understand inflation,
they cannot comprehend the annual inflation levels that commercial property owners incorporate into their rental increases.
The U.S. inflation for the last 10 years has
averaged less than 3 percent compounded,
yet commercial owners have increased
rents closer to 15 percent compounded per
year.
These extravagant inflation averages
make sense to landlords because their
math has been reverse-engineered. The
landlords pay whatever they need to in order to secure the purchase of the property, then they look back into the rental rates
required in order to support the purchase
price. Supply and demand, positive or negative net absorption, job gains or losses —
those notions don’t have one iota of influence over this rent calculation. These landlords are operating in a vacuum, so why
should they be concerned about worldly
issues like employment data?
How can a tenant combat this tilted playing
field?
The negotiations favor the house or — in
this case — the building and its owner. Not
unlike Las Vegas, the house wins far more
than it loses.
It’s very important for tenants to play the
game with all of the advantages available.
This is where tenant representatives are
invaluable. While they may not have all of
the aces up their sleeve, they are able to
see the cards being held by the landlord.
For example, regardless of how much a
landlord is asking in rent, it is important to
know how long the space in question has
been vacant. Additionally, is the building
well run, and will the tenant actually enjoy
being in the building in several years? Or
worse yet, does the landlord in question
nickel-and-dime tenants to death in order
to work his yield?
The way to combat this growing problem
called ‘arbitrary landlord markups’ is to be
represented by someone smarter, better
educated and craftier than the landlords.
Office leases are labyrinths of staggering
complexity, requiring an expert advocate
to protect tenants from being skewered
with myriad hidden costs. Tenants often
don’t even know the questions to ask,
much less the answers. They need competent help.
JASON HUGHES is a principal at Irving Hughes Inc., in San
Diego. Reach him at [email protected] or (619) 238-4393.