Why timely due diligence is vital to real estate negotiations Featured

9:01pm EDT October 31, 2011
Why timely due diligence is vital to real estate negotiations

It’s a common mistake that business owners make: waiting too long to address an expiring commercial real estate lease. Sometimes the time just gets away from them. In other situations, they might even think they can sign a quick renewal and be done with it. Whatever the reason, waiting until the last minute is a sure way to leave money on the table.

“I am often asked by business executives when they should start addressing their expiring leases,” says Robert Chavez, founder and CEO of Guardian Commercial Realty. “While the answer varies depending upon circumstances, the time to start due diligence is much sooner than most expect.”

Smart Business spoke to Chavez about how timing is everything when renewing a lease.

Why is it important to begin early when addressing expiring leases?

I like to use the analogy of buying a new car to illustrate the answer to this question. Suppose you were to walk into a dealership, ask how much the shiny new car in the showroom cost, and then wrote a check for it a few minutes later. You would likely pay a lot more for the same car than your neighbor who visited the dealership several times, asked questions about other automobiles in the same class and then finally arrives ready to purchase at the end of the month when the dealership needs to make its sales quota. By doing some research, making the sales person (and likely sales manager at this point) aware that he has done his homework along with being patient and strategic, the neighbor saves many thousands of dollars purchasing the same car.

On a much larger scale, leasing or purchasing office space is similar. Tenants that wait until their lease is near expiration send a dangerous signal as their landlord realizes they are essentially out of options. They do not have time to negotiate another lease and relocate. Landlords take full advantage of this knowledge and hold to a high rental rate with little or no concessions. They are aware that the tenant has painted itself into a corner. When they are facing an expensive ‘holdover’ tenancy or threat of eviction, the landlord is able to leverage tenants into a bad lease. Waiting too long can easily cost a 10,000-square-foot tenant upwards of $600,000 in lost opportunity over a five-year term.

When is the optimal time to focus on an expiring lease?

My rule of thumb is 18 months on average. Longer for very large leases, and somewhat shorter for smaller leases or building purchases. I find that it generally takes most tenants longer than they anticipate to truly focus on important or sensitive internal issues that will impact their real estate decisions. Multiple parties may be involved in such decisions, which always require additional time. Business circumstances may also change and it is important to have ample time to react. I like to have at least three months, at the outset, to feel comfortable that a client has really come to grips with its strategy and direction. Once a tenant finally does decide what it wants to do, it takes much longer to convince a landlord to agree to an appropriate transaction. Landlord also have their own agenda and timetable, so it is imperative that ample time is allocated for landlords that are difficult and/or slow to respond.

Is there ever a time when due diligence is not necessary?

Many tenants feel that because they want to remain in their existing space that there is no need to conduct extensive due diligence. That is a big mistake. Landlords and their own agents talk amongst each other to understand who is active in the market. They also ascertain important information from furniture vendors, architects and others in the real estate support factions regarding which tenants are in the market. If tenants in their building are not on the radar, then landlords are less concerned about losing them to a competitor and important negotiating leverage is lost.

How can tenants make sure they have a strategic advantage during negotiations?

Astute tenants will take time to interview several real estate brokers. It can be a big mistake to assume that the broker they used last time is still a good choice years later. Once selected, a good broker will assist with:

  • Site selections
  • Evaluating and interviewing architects
  • Touring space
  • Drafting and negotiating material business points in proposals and letters of intent
  • Reviewing construction budgets
  • Aggressively negotiating key sticking points to close a transaction in the tenant’s favor
  • Assisting legal with document critiques

There is even more work to do once a lease or amendment is signed, but understand that all these steps take time to properly complete. Once completed, and the tenant is now fully informed with regard to its choices, cost and risk, it is surprising how many do elect to relocate based on the data. I have had many instances where a client has stated firmly at the outset of a transaction that they will not relocate, only to see them jubilant over an opportunity that far exceeds their initial expectations.

As is typically the case, hard work does pay dividends. Fortunately for tenants, they can hire a real estate broker early in the process to do the majority of the legwork. Their brokers can spot changing market conditions that their client may miss, or find a unique opportunity perfectly suited to the tenant before it hits the open market. The sooner you get started, the more time you give your broker to work on your behalf.

Robert Chavez is the founder and CEO of Guardian Commercial Realty. Reach him at Robert.Chavez@guardian.net or (310) 882-2060.