We turned to a real estate industry expert to get the inside scoop for you on how to navigate the lease negotiation process for your next project.
Today’s real estate environment can make the lease negotiation process challenging, but navigable, if you balance your company’s needs with the issues facing many landlords. Your prospective landlord is probably concerned about the same things you are: the threat of a national economic recession, increasing operating and occupancy costs, increasing construction costs of new buildings and tenant improvements, and the lack of financial liquidity in the debt markets.
At the same time, the last few years in the real estate market have generally been good ones for most real estate owners, which means many are not yet at the point of thinking about dramatically reducing rents.
Clearly defining your needs, understanding market forces, and finding common ground on the details are all essential to successful negotiations and can result in a lease that is favorable for both your company and your prospective landlord. Here are some of the finer points to consider as you enter your next lease negotiation.
Understand Your Space Requirements
Not all real estate is created the same; it is important to evaluate your space requirements and how they match up with—or limit—your choices. Here are questions to consider when trying to fulfill your space needs: What is your budget? Is your existing space sufficient to meet your needs? What building features are essential for the operation of your business? Is visibility from or access to a major road necessary? Are you subject to “green building” requirements, or will this be a requirement in the future?
Equally important to understand is how the space will impact your employees. What are the area amenities that are important to your employees? What amenities will attract the top talent in your industry? Will the space help employees be more productive? Access to the building, newer space, better lighting, and safety issues all affect employees’ daily productivity and play an important role in site selection, rental rates, and tenant improvement negotiations.
Keep in mind that too many special requirements can limit your site selection options and negotiating power. If the features and amenities you require are not readily available at other competing properties, you will likely pay more for the space.
Tenant improvement costs have dramatically increased over the last couple of years. For new, unfinished space, you can expect that the level of finish you desire is going to cost 20 percent to 50 percent more than it would have just two years ago. In some cases, the developer may not have enough money in the budget to finish out the space beyond a reasonable minimum requirement.
These are the best strategies to negotiate tenant improvements:
• Be reasonable in your expectations. Generally, landlords can justify stretching and providing a larger allowance for tenant improvements—that is, if they believe the dollars represent value for the space in the long term.
• Consider funding the additional dollars yourself if reducing your rent is a major consideration.
• Consider increasing the term of your lease to show your commitment to the space and allowing the landlord an opportunity to amortize additional improvement dollars over a longer term.
• Don’t ask for tenant improvements that you don’t really need. Focus instead on lower rent, reduced rental increases, or abated rent as potential concessions.
• Consider existing space where improvements are already available, since landlords will usually be more flexible if they don’t have to fund additional tenant improvements.
Generally speaking, from a landlord’s perspective, the longer the term of the lease, the better; so consider a lease that is as long as possible for your business. Landlords get peace of mind and garner greater value with longer-term leases. You should be able to pay a lower rate for a slightly longer-term lease, all other factors being equal. A shorter-term lease may offer more flexibility for the tenant, but often comes with a higher rental price tag.
Current rates are largely a function of economic conditions and the rising costs of doing business. In particular, construction costs have skyrocketed over the last few years, leading property owners to charge higher rental rates to offset these increases.
Recent economic conditions stemming from the subprime lending crisis are also slowing the flow of debt available to build new space. As a result, many owners are having to fund projects with more of their own equity in order to minimize the debt load. With the increased financial investment in new buildings comes increased yield expectations that are forcing owners to charge higher rent.
Most new space was built with a certain yield expectation in mind. If you are able to pay close to a landlord’s asking rate and receive some relief in the form of abated rent, then you will help your landlord meet his needs while reducing your overall costs.
Keep in mind that while you may be able to negotiate rent concessions in the form of rent abatements, expect that the landlord will still require you to pay your fair share.
TENANT’S CREDIT WORTHINESS
If you have good credit, use this to your fullest advantage during the negotiation. Most landlords can offer lower rental rates and a larger tenant improvement allowance to prospective tenants with great credit.
Companies with an established brand, a strong reputation in the marketplace, or a long history of operations are considered highly desirable tenants. When signing on as the first tenant of a building, these companies are especially attractive because they effectively give the building a seal of approval that will help the landlord attract other tenants to the remaining space. Companies deemed “desirable tenants” should use this to their full advantage during lease negotiations.
Landlords typically do not want to grant renewal options at fixed rates, as it limits their yields and, therefore, the value of their property. At most, you may expect to negotiate a cap on the rate that reflects a set percentage increase over the rent you paid in the last year of your base term. Market rate options are still the most common terms.
Rights of first refusal can be deal-breakers for landlords because they can limit the marketability of their space. If expansion options are important to your business, consider asking for notices from the landlord when space is available and negotiate a fair deal then. After all, it is a lot easier for a landlord to lease additional space to an existing tenant than to start anew with an unknown tenant.
Steve Golding is President and COO of Jackson-Shaw Company, a national real estate development organization with over 37 years of experience in the development and management of hotel, office, industrial, and flex facilities. The company’s portfolio includes over 35 million square feet of construction and development.