Smaller businesses have great opportunities in real estate right now as lessors struggle to fill vacancies.
Refinancing has become a big issue in the commercial real estate industry. Hundreds of billions of dollars of commercial loans are maturing over the next few years and the current financial condition of many properties will not support their debt service payments nor meet the financial requirements necessary to refinance without contribution of additional equity from the owner(s).
Termination of long-term leases is on the rise as a result of many business failures and has significantly impacted future revenue streams to properties. This has led to lower net operating income and property values. In many cases, the market value is appraised lower than the mortgage on the property.
“Properties of all types are facing higher vacancy rates, requiring landlords to be creative,” says Marc Newman, CPA, assurance manager of real estate services at SS&G Financial Services, Inc. “Landlords are offering sweetheart deals, leasing space to unconventional tenants and providing more concessions to fill vacant space as a short-term solution, giving business owners more negotiating power when executing a new lease or renegotiating terms of an existing lease.”
Smart Business spoke with Newman about how to take advantage of a down economy to find the best deal for your business, whether you’re looking short term or long term.
How can businesses take advantage of a down commercial real estate market to get a better deal on their leases?
As lessors refinance maturing debt, the ability for properties to provide banks with budgets that include sufficient revenue streams to support future operations and debt service payments is critical in refinancing. This gives tenants or potential tenants the opportunity to negotiate more favorable lease terms.
A tenant could approach a landlord and say, ‘My current lease is set to expire within a few years and I recognize the value a long-term lease can provide. I am willing to execute a new long-term lease if you are willing to terminate my current lease, without a termination fee, and reduce my monthly rent.’
Many landlords will be agreeable. The long-term lease will provide a guaranteed revenue stream. Plus, the business will lock in lower monthly rents. It may also be a good idea to execute a long-term lease in order to lock in option periods at lower monthly rents.
What other opportunities does the economy present for business owners?
There are now opportunities for smaller businesses that do not currently occupy space, such as home-based businesses. Lower rents provide access to space as well as to customers and foot traffic they would not normally be able to reach.
While lessors want to execute long-term leases to guarantee future revenue streams, they also need to fill vacancies and are willing to do what they can to fill them. This gives smaller businesses the ability to negotiate more favorable lease terms while not necessarily having to be committed to a long-term lease. Businesses may even be able to access rental space on a month-to-month basis, which allows a business to walk away from its space without having to pay a termination fee.
In addition, the lessee has the ability to negotiate concessions, such as a period of free rent, a tenant improvement allowance, or an allowance to cover relocation expenses.
What else should a business look for before deciding to commit to a lease?
It is important to consider location. For example, if looking at space in a lifestyle center, there will likely be at least one anchor tenant, usually a big box tenant. It is important to understand who the anchor tenants are. In this economy, it is unlikely that a grocery store will vacate their space, whereas an electronic store may.
If a business is in a location where the anchor tenant has vacated, the lease may contain a co-tenancy clause allowing the lessee to pay a reduced or percentage rent for a period of time or to terminate the lease early if the landlord is unable to find a new anchor tenant within a period of time.
Having a lawyer or accountant review any lease prior to executing is a good idea. Most business owners are not familiar with all the nuances of a lease, like a co-tenancy clause, or the rights they have under the terms of the lease.
How can a business save money after it already signed a lease?
A common clause included in leases is a provision allowing the lessor to pass through common area maintenance and real estate tax costs. A tenant has the right to audit the lessor’s books and records to verify the lessor’s calculation of the tenant’s share of common area maintenance and real estate tax costs, which could result in potential savings.
Another provision typically found in leases allows the lessee the right to their share of any refund of real estate taxes received by the landlord. Often, landlords petition a property’s assessed value used to calculate real estate taxes. If the assessed value is less than what had originally been used, the landlord will receive a refund, which should be passed on to the lessee.
Does the down economy also make this a good time to buy commercial real estate?
There are opportunities to purchase commercial real estate at a significant discount, but many questions must be addressed. If a distressed property is underwater, do you have sufficient capital to cover the financing gap or obtain financing? Would you want to tie up that much cash in an uncertain time? Will you need to provide a personal guarantee? Will increased interest from others drive the purchase price higher? Careful consideration and due diligence must be exercised prior to a final decision.
Marc Newman, CPA, is an assurance manager of real estate services at SS&G Financial Services, Inc. Reach him at (800) 869-1835 or MNewman@SSandG.com.