TOPIC: 7 Ways To Maximize The Value Of An Office Lease Renewal

Presented By Mark D. Rauch

"Before everything else, getting ready is the secret of success."

-Henry Ford-

Many tenants assume their lease will be renewed on reasonable terms and accordingly leave a perfunctory amount of time for the renewal to be handled. Then it turns out that the landlord's draft proposal involves substantially higher costs than anticipated. Because there isn't enough time to determine if a better alternative can be negotiated elsewhere, such tenants are stuck. That's why a lot of tenants often end up swallowing a bad deal.

At the very least, you can bet that as a renewing tenant, your landlord will offer terms inferior to what is being offered to new tenants now. After all, new tenants are in the market shopping around. To attract new tenants, the landlord must be willing to match the competition in terms of rent, free rent, utilities, workletter, building systems, communications capability, security systems, electrical capacity, lobby appearance and other factors. But if you are a tenant interested in a renewal, the landlord presumes - and tends to be right - that you're not shopping around much. The landlord figures you're mainly concerned to avoid the cost and disruption of a move, and he can probably keep you in the building without offering you nearly as much as he offers a new tenant.

If you assume the cost and disruption of moving are so high that your only good option is to renew your lease, it will become your only option. You will be a captive market, and you could easily miss substantial benefits your landlord offers as inducements for new tenants.

Here's a proven strategy for maximizing the value of any renewal -- even if you are 100% committed to staying at your current location.

1. Use time to your advantage

You need to start early enough so you have time for all the normal phases of site selection, financial negotiation and analysis, lease negotiation -- plus time to walk away from a bad deal and continue negotiations elsewhere if need be. This means if you plan to renew at your current location, for a lease in the 50,000 sq. ft. range, you should be actively assessing your options at least 18 months before your target move-in/renewal date.

You could be in for a shock if you let time slip through your fingers. A well-known communications firm explored with its landlord terms for a fairly short-term lease renewal. The landlord agreed to concessions worth about $500,000. Negotiations concluded, but the tenant neither acted nor developed other options. Months later -- about 12 months before lease expiration -- they responded to their landlord and said they were ready to proceed. The landlord assessed his options -- particularly noting that the tenant had not developed alternatives -- and replied: "I'd like to proceed, but times have changed. The $500,000 we talked about isn't on the table anymore."

2. Understand your options in the marketplace

If you don't have a good idea what lease terms other tenants in the marketplace are getting now, then you have no way of determining whether a landlord's proposed renewal is a good deal or a bad deal. Your landlord's offer could easily be inferior to what tenants In similar markets are getting, in which case it would qualify as a bad deal even though it might be an improvement over your original lease.

Rent and workletter allowance are just the beginning. Every bit as important are terms buried in the fine print, terms which can undermine what you assumed to be a good deal. For instance, the operating expense clause, electricity clause, use clause, sublease clause and all clauses relating to landlord performance standards.

A professional services firm planned on a lease renewal. They had a thirty-year history at their building. It was convenient for all the executives and for clients. They were reluctant to even consider looking at other options. After showing the firm many alternatives to their current location and developing financial models showing what the firm could expect to get in the open market, The Tenant Rep entered into negotiations with the tenant's current landlord. The Tenant Rep reduced the tenant's costs compared to ownership's initial offer by more than 20% in a rising market, and secured a variety of additional non-rent, operational concessions.

3. Use your inside knowledge of your current building and/or landlord's operations to formulate the terms of your renewal deal

As a long-time tenant of the building where you plan to renew, you have a key advantage that can help you secure improved lease terms. You know the physical characteristics of the building and how it has functioned in the past. If you have always been dissatisfied with the way the common area bathrooms look, elevator waiting times, how the HVAC system functions, etc., your advisor should be specific about these issues in negotiating your lease renewal. Seek specific quantifiable improvements. Calculate a reasonable dollar value for each improvement to be made and stipulate a penalty or consequence if changes agreed upon are not made within an agreed-upon time period. Implement the changes agreed upon with effective business terms in your new lease.

4. Analyze your current lease in terms of business and operational terms that have been inadequate, too costly and not operated as you expected.

If, during your years in your particular building, you have had regularly performed detailed annual escalation audits, this puts you in a position that can be extremely valuable to you in structuring a lease renewal. Done properly, these annual audits show you how efficiently your landlord runs the building, what the mark-ups are for certain kinds of important as well as incidental services you may require. Moreover, these audits will show you whether your landlord bills twice for the same services, whether you are paying for services supplied to other tenants, whether your landlord uses insurance reimbursements as a cost center, and how your costs compare to the market. Use this information in improving critical business and operational terms during an extended lease term. In the hands of an effective Tenant Representative, the data generated by these audits gives you a second chance to secure the lease terms you really wanted the first time around.

5. Let your landlord know you are actively seeking alternative solutions for your space needs.

Preserving good relations with a current landlord is often cited by tenants as a reason for "going it alone" when it comes to handling a lease renewal. The unfortunate effect of such a strategy is that it reinforces ownership's belief that you have no options and don't take the prospect of lease negotiations seriously. It's a clear sign that you are prepared to settle for whatever is offered.

Handling a lease renewal should be treated like any other business operation -- the management team makes a reasoned assessment of all relevant options and selects the best fit. It's important to let ownership know that this is your approach to whatever terms they might offer -- or expect you to accept in a lease renewal.

Early during one renewal negotiation that a tenant rep handled for a tenant, they spoke with the landlord about various concessions that were sought. The landlord readily acknowledged that at the rent levels we were discussing, he would give a new tenant a full build-out, six months free rent, and certain other favorable terms. To the tenant he proposed virtually no work and no free rent. His reasoning: "They're here already, and they don't need it. Maybe I'll give them some new carpeting." Note that carpeting would have been worth about 10% of the concession offered to other tenants paying the same rent.

The Tenant Rep let ownership know that they expected the dollars offered to the existing tenant would be just as much in leasehold value as a new tenant's, and were prepared to seek the most cost-effective alternative in the marketplace.

When a landlord understands that you are having a tenant representative objectively evaluate the marketplace, they are likely to become more realistic about what you renewing your lease is worth. By making sure ownership knew the tenant was serious about its options, the tenant ultimately secured concessions very similar to those being offered to new tenants, and a more favorable rent structure.

6. Understand what it will cost your landlord if you move out.

A common stumbling block in renewal negotiations is the undeniable fact that no matter how a good a deal you will get by moving, you will also incur costs that may be substantial -- the cost of the physical move, new telecommunications wiring, perhaps costs of building out their new space that go beyond what ownership will supply, new stationery, perhaps new furniture, etc.

Yet the landlord, too, will incur substantial costs if you leave for more favorable terms elsewhere. For instance, potentially lost revenue, promotional costs, brokerage commissions, infrastructure refurbishment, demolition costs and build-out costs. In every situation, these costs can be quantified with a high degree of accuracy, and should be part of discussions with landlord to maximize the value you get as a renewing tenant.

The differential in these costs -- what a landlord will spend to attract a new tenant, and what they will spend to retain you -- can be substantial, and easily exceed a year's rent. With an astute tenant representative and a properly structured negotiation -- some portion at least, of these savings, can be used to further reduce your costs should you elect to renew at a current location.

7. Be prepared to move if you can't get market-rate terms or if the space no longer works.

Ultimately, if your analysis of the market, taking into account all relevant factors, shows that a substantially lower present value occupancy cost will result from moving, this is probably the option you should select. Moving for marginal savings - 2% or 3% -- might not be warranted, but if projected savings are 5% or more, this is likely to be your better option. No matter how specialized your facility, no matter how convenient its location, no matter what the cost of build-out, if a comprehensive site selection process, financial and lease analysis shows you can get better terms elsewhere, it may be time to move on. Occupancy costs are often the second largest fixed cost a tenant faces; in total they may consume up to 50% of net revenue. Managing occupancy costs is a critical corporate responsibility. When landlords understand that lease renewals are not a "sure thing"; when tenants regularly subject lease renewals to an objective, market-driven process, the result is likely to be reduce occupancy costs across the board.

Nothing contained herein is to be considered legal advice. Always seek legal advice when evaluating any legal document.