Lease renewals are not always conducted on a level playing field. After all, the landlord is in the real estate business and the tenant is not. By planning in advance and having professional assistance, tenants can increase the probability of negotiating a discount when renewing.
“Companies should plan ahead to allow ample time to complete a renewal,” says Rick Messey, CCIM, vice president, Colliers Turley Martin Tucker. “Companies that fail to do this lose considerable leverage as landlords see the tenants’ options dwindle.”
Smart Business spoke with Messey about the lease renewal process, the importance of starting early and what qualities to look for in a real estate broker.
How does the lease renewal process work?
An important clause found in most leases is the renewal option, which allows tenants to extend their leases for a predetermined amount of time (usually three or five years) by giving their landlords six to 12 months written notice. Renewal options specify rental rates, concessions, tenant improvements and whether a new base year for operating expenses will be granted. These options are sometimes fixed amounts or subject to the fair market value conditions.
What are some common mistakes that companies make during the process?
One of the most common mistakes companies make is negotiating without the help of a commercial real estate professional. Companies believe they can save money by not using a broker, but to benefit in real estate, you need leverage. Landlords are in the real estate business and negotiate with professional guidance, so why not level the playing field? Savings received from using a broker exceed the cost of commissions.
Another mistake companies make when entering into a lease renegotiation is being unfamiliar with their current lease terms. Prior to contacting their landlord about renewing, every company should be well aware of every option and deadline within their lease. As mentioned, most leases contain options that must be exercised within a specific time period, typically nine to 12 months prior to their lease expiration. If, a tenant allows said time period to pass, they risk losing all rights outlined in the option.
What type of cost savings can be extracted during the renewal?
Tenants in a bear market can receive significant cost savings. As the economy weakens, companies continue to lay off and downsize their work forces. Landlords will be feeling the pinch and will offer aggressive concessions and more attractive lease terms to lure new tenants or maintain current ones. Now more than ever, a qualified commercial real estate broker can assist companies in reducing overall occupancy costs and improving profitability. The savings will depend on the availability of competitive vacancies, the efficiencies of the buildings, the market knowledge of the broker and the broker’s ability to negotiate business points and reduce overall exposure. Some of these risks are often found in the operating expense and expansion/contraction options in the lease.
When should a company start the process?
As a rule of thumb, the larger the tenant, the greater amount of time needed to finalize and leverage a renewal transaction. Larger tenants should consider their options several years in advance so that all viable existing and new properties may be considered. New developments or speculative properties often attract larger tenants. These new developments could receive financial incentives, like tax abatements, or federal and state incentives that could be passed along to the tenants. In addition, newer buildings often provide larger tenants more efficient floor plates and advanced mechanical systems that use less energy than their older counterparts. These occupancy savings can all be quantified and compared to the existing renewals on an apples-to-apples basis.
Smaller tenants should consider the renewal process 12 to 18 months in advance of their lease expiration, regardless of what their renewal option dictates. This is recommended so that the tenant can consider and compare all relocation options in the market. Secondly, tenants should begin negotiating any relocation options before their lease options expire. Tenants who miss their lease options incur more risk, as landlords often treat them differently. Landlords view this as an opportunity to push rents higher as the window of opportunity to relocate closes. If tenants holdover, they often see penalties of 150 to 200 percent of their last month’s rent and could also incur consequential damages if they holdover without permission.
In what ways can a company benefit from engaging a quality real estate professional?
Real estate costs account for a significant portion of a company’s overhead. Real estate professionals can provide the guidance needed to minimize costs associated with occupying commercial space. A good broker will possess the following qualities and tools: upto-date market knowledge, expertise in negotiating leases, the ability to provide a detailed financial analysis on a comparable basis and construction expertise. Brokers help companies achieve both short- and long-term goals by asking the right questions. They save companies time and money by being intimately familiar within a specialized market. This, in turn, reduces the tenant’s overall occupancy costs, increases profitability, mitigates lease risks and minimizes time.
RICK MESSEY, CCIM, is the vice president of Colliers Turley Martin Tucker. Reach him at (314) 746-0318 or firstname.lastname@example.org.