Smart lease renewals

The best way to grow revenues is to
keep customers instead of letting
them flee to competitors. Usually, the approach works.

Consider the discovery by Equity Office
Properties, one of the nation’s largest office
building landlords. It conducted an internal
study to find the best way to increase revenue. Their report concluded that raising
rents across their portfolio by $0.10 per
square foot would increase revenues by $4
million. However, increasing their average
occupancy by just 1 percent would increase revenues more than $40 million.
Clearly, for an office building owner, keeping those properties occupied is a very high
priority.

Yet according to Craig Knox, vice president of Irving Hughes, landlords often play
hardball when negotiating with existing
tenants who simply want to renew their
leases on favorable terms.

“It seems crazy, but at lease renewal time,
landlords are offering existing tenants
above-market rents with little or no concessions. They think they can get away
with it because it worked in the past,”
Knox says.

Smart Business spoke with Knox about
real estate lease renewal negotiations and
how business owners can improve their
lease terms while remaining in their current building.

Why does it cost a landlord so much more to
find a new tenant than to renew an existing
one?

When an existing tenant decides to relocate, it really opens up a Pandora’s box of
escalating costs and lost opportunity.
Obviously, while the space sits empty,
there is no rent. Considering that the
average time it took to get space leased in
San Diego County in 2006 was more than
15 months, that adds up to a lot of lost
revenue.

When the landlord finally does find a
new tenant, it is unlikely the tenant will
accept the space as is, but will rather
expect the landlord to build out improvements. Add to that other financial incentives tenants ask for including rent discounts, free rent periods and moving
allowances.

Beyond the hard dollar costs, a landlord
is taking a risk with a new, unknown tenant. Should that tenant fail to perform
under the new lease, you can bet the landlord will regret ever letting the former quality tenant move out over a desire to make a
few extra bucks.

Then you are saying it’s a windfall for the
landlords when a tenant renews?

Exactly. A huge windfall. Yet they
would never want their existing tenants to know that, because then the
tenants will naturally expect a share of
the savings.

How does the lease renewal process usually
work?

Unfortunately, companies often just exercise renewal options contained in their
original lease, which provide a right to stay
in the space at some form of ‘market’ rent.
These options are rarely the best choice
because they force the tenant to commit to
an extended term before they know what
the space is going to cost. Worse is that
exercising the option absolutely negates any leverage the tenant may have in negotiating a favorable lease extension.

Even if the landlord offers to discount the
rate, the tenant should not be lured into the
landlord’s process. The savvy tenant will
drive the lease renewal process with the
same focus and attention as in the original
lease negotiations commanded.

What is the right lease renewal process for a
tenant to follow?

We follow a very similar process
whether our client believes a renewal or
relocation is the most likely outcome.
Our process is deliberate and designed to
provide our client leverage in all possible
scenarios.

In general, we evaluate the tenant’s existing space utilization, identify areas for
improvement, and then develop viable scenarios that save money, improve the work-place environment, or both. With alternatives in play, we can begin a dialogue with
the existing landlord about the terms under
which our client would consider an
extended lease. It’s more than just a negotiation about rent. We save money by getting a new base year, negotiating allowances to remodel the space, obtain enhanced signage and parking rights, structure expansion rights and other concessions that the tenant won’t think of.

Can a tenant accomplish the same on his
own without a broker?

The best renewal negotiation occurs
when the landlord thinks that the tenant
has one foot out the door. The landlord’s
leverage when we tell him that our tenant
is looking at moving and might renew is
completely different than when the tenant
tells the landlord he has decided to renew.

By not hiring a tenant-rep broker, the
tenant is sending a clear signal that relocation is definitely not a consideration —
and that dramatically reduces negotiating
leverage.

CRAIG KNOX is vice president at Irving Hughes. Reach him at
(619) 238-3825 or at [email protected].