Timing Is The Key To Negotiating A Lease Renewal

Negotiating a renewal of your office lease can seem like a dicey situation.  By the very expression of interest in renewing your lease, the landlord knows that the premises are meeting your needs and that moving your business is the last thing you want to do.  If you are paying market rents presently and if the landlord offers a market rate for your renewal, it can indeed be an easy decision and one that is easy to document.

But what if you are paying a little over market, economic conditions have changed – just consider the current climate, or you want or need a concession to justify staying put?  What do you do then?  A simple rephrasing of the question reveals the answer.  How do you get the same enticing deal the landlord is offering new tenants coming to the building?

The key is disavowing the landlord of the notion that you are a captive audience.  They need to realize that you have a choice to stay or leave and that you are willing to exercise that choice.  This can be accomplished with one simple act on your part: broach the subject with the landlord 9-12 months before your expiration date.  A good tenant rep broker can push the reset button on the landlord’s expectations and do the market research to back it up.  Now you have turned the tables and have the landlord asking themselves a question: do we want to keep this tenant or lose them?  This is a situation where it is very wise to have an intermediary act on your behalf and shield your true intentions to stay but get the best terms possible.

And hey, what’s the harm in taking a look into market conditions and maybe even touring a few buildings to get some fresh perspective on what is out there?  You might even garner some ideas of upgrades that would make your office space more enticing and attractive to your employees.

Be smart -- get a head start.

The Office...To Be Or Not To Be

Here we are…ten months into the induced coma known as the pandemic’s restrictions on human interaction.  The long-term view on business survival and the effects on the way we work have changed a lot since April, 2020.  In particular, the impact of the sudden changes in the way we work and interact has skewed everyone’s view of the relevance and role of the office…and office buildings. 

Here are the dramatic numbers: since the pandemic, Kastle Systems has been studying keycard and fob access data from 3,600 buildings and 41,000 businesses in 47 states to identify trends in how Americans are returning to the office.  Los Angeles now leads the Barometer with an occupancy rate of 27.5%, followed by Dallas at 24.2%, Houston at 22.8% and Austin at 22%.

There are those who are ready to jettison all office space and pivot to a virtual workplace.  Note that this is different from virtual work.  We have all done that to a degree for the past several years evidenced by people taking their laptops everywhere and being glued to their cell phones.  (See that woman outside of Starbucks who is making her way back to her Mercedes roadster?  I assure you, she’s not looking at funny cat videos.) 

On the other hand, there are those who think that the place in workplace cannot exist virtually – that the human need to contact and in-person interaction is not being nurtured on Zoom. 

Change in fundamental aspects of our lives can be daunting. Stay courageous.

Telling The Story Of Tenant Creditworthiness

One of the most daunting challenges associated with leasing commercial space for a small or new business is showing sufficient financial strength to satisfy a cautious landlord.  I tell my clients to pretend they are going into the bank to get a line of credit or are pitching an investor.  Present yourself in the best possible light.  Be honest but at the same time optimistic.

Pitching your financial strength is like telling a story.  There are two key aspects to the story: the numbers and the narrative.  If your rich uncle Albert is prepared to back up the lease with his $22 million net worth, that’s about all the story the landlord needs.  But short of raw, financial heft, there are any number of other things that indicate business savvy and staying power.

·        Longevity – How long have you been in business?  If you have been operating profitably for five or more years, say so.  A long history suggests continued stability.  If the enterprise occupying the space is a relatively new venture, then tout how long the principal has been in the subject industry.  That will give the landlord confidence that the tenant understands the business and knows what they are doing.

·        Trajectory – Have revenues been growing over time?  Share profit and loss statement over the past 2-3 years that plot a pattern of growth.  Most landlords will envision continued growth.  Even if you have just been in business for a year, showing sufficient revenues to back up the rent and positive forecast for future revenues will give the landlord some comfort.

·        Business Plan – Share some knowledge of your industry and your specific niche.  Outline the profit potential and show the landlord how you are smartly targeting that opportunity.

I not only coach my clients on how to formally present this information, but I insist on understanding the story myself so I can confidently communicate with building brokers when they inevitably ask “What does your client do?”

Know that the landlord’s imagination will fill in the blanks.No news is bad news.But if you provide compelling facts that resent a vision of success, the landlord’s imagination will just enhance it.Graffiti or Goya…it’s up to you.

Please...Trust Me!

I am currently working through the lease documentation phase on behalf of a fine dining, continental-style restaurant in one of the most desirable submarkets in Los Angeles.  It is a 10 year lease and the tenant (my client) is justifiably a little anxious working through the details of the lease contract.  Next to a mortgage, a commercial real estate lease might the biggest contractual obligation business people will ever enter into.  Who can blame them? 

That anxiety is good when it results in attention to detail and a desire to clearly understand every clause the lease.  For that, my patience is bottomless.  But other times, it bubbles up as interference with forward progress.  Then it’s me that gets anxious.

My client and I received the first draft of the lease from the landlord – a big national firm with its own in-house legal department.  In the lease draft, there were a few instances where the language the lawyers used did not match up with the terms we arduously negotiated.  The tenant emailed me back with their comments, understandably concerned.  I confirmed their observations, provided guidance on each one, and sent them back the lease draft with my “redlined” changes.  I instructed them to send my markup to their attorney so he could review the lease, add his own comments, and change mine if he saw fit.

The next day, my client emailed me again and asked if I had discussed their concerns and the mistakes in the lease draft with the landlord’s leasing representative.  “No” I said, explaining that these mistakes are not uncommon and that they would be corrected in the back and forth of the lease comments process…and asked if they had sent the lease on to their attorney.  They said that they had put their attorney on standby until they could get a corrected lease draft.  I grimaced.

Were they wrong to want the lease to be worded clearly and correctly?  Of course not.  But I urged them to trust me – I have worked through hundreds of lease negotiations.  Asking the landlord to make minor corrections before sending the lease to their attorney was a waste of their own precious time and would be unnecessarily aggravating to an institutional landlord like this one.

After some soothing strokes, I got the tenant to see it my way and progress resumed.  I think all professional advisors would agree: sometimes the most important negotiating you do is with your own client.  And it’s always for their own good.

It Is Time To Completely Rethink Your Office

Corporate C Suites around the world are wrestling with a fundamental and conceptual rethinking of their office strategy, ranging from “do we eliminate them altogether?” to “do we need more space to allow for social distancing?”  No wonder they are confused about which way to turn.

Now more than ever, businesses leasing office space need an advocate who is well versed in workplace planning and local real estate market conditions who can help direct the conversation.  There are good, executable strategies for every company but no two are exactly alike.  Here are some of the topics that need to be carefully examined:

·        Which of our staff positions can work from home full time or part time?

·        How does a work from home policy affect the corporate culture and productivity?

·        Does a downtown or suburban location best fit our business objectives?

·        What business functions should our office space serve?

That last question is the big one.  The traditional concept of the office is “the place where everyone does their job.”  But with every firm making a concerted effort to allow at lease some of their staff work from home, other functions come to the fore: training, company-wide meetings, client presentations, and corporate functions, to name a few.  Unlike any time before, decision makers are planning their office strategy on a clean slate.  It is an exciting time and the decisions you make over the next couple of years will impact your business for many years after.

Remember when we all wanted the teacher to pick us to be the blackboard monitor and hand us the eraser?  As a real estate tenant rep broker with 40 years in the business, it’s finally my turn!

Sublease Your Offices With A Smile On Your Face

A lot of office tenants find themselves with more than a few empty offices that they want to sublease to offset their rent obligations.  This is a good idea if your lease allows it (most do.)  But there is a bit of flair involved if you want to get a response to your ad.

The first is, understand your competition.  That is a pretty standard rule for any type of sales, of course.  So who is your competition?  Well other office tenants in your trade area that are trying to find someone to fill a few offices, of course.  But the real competition is the executive suite and coworking operators.  Think Regus, Premier, Barrister, and WeWork. 

The key therefore to getting people to call on your offering is to differentiate yourself from the executive suites. Appeal to the small independent professional who doesn’t need all of the ancillary services that executive suites offer, like mail sorting, phone answering, and a corporate environment with a big, elegant lobby. 

I helped a client of mine create their ad.  I coached them to price the private window offices and the furnished workstations they had available significantly below the executive suite operators in the area.  I also told them to emphasize the small, friendly atmosphere of their office and several of its features, one of which was a small kitchen.  I had one suggestion: after “Small kitchen” I suggested they add “FREE COFFEE!!!”  Being charged for every cup of coffee at many of the executive suites is a major complaint from people that rent space at those facilities.  With a little bit of friendly humor and a wink, they addressed – and answered – that complaint.

If your audience has a beef, make sure you get to the meat of the matter.

Sometimes You Have To Knock Heads To Get Them Together

I have recently been working with that rare retailer – one who has been doing reasonably well even during the horrible pandemic conditions.  I found him a fantastic location and both the landlord and tenant wanted to make something happen.  But they were not seeing eye to eye on the rent methodology.  Each had a concern with the other’s approach and they just seemed uncomfortable jumping the divide or even meeting half way.  Let me tell the rest of the story by sharing my email I sent to both of them as a last ditch effort to bring them together (changing the names to protect their privacy)…

Bill and Maurice,

It is very unorthodox for me to send an email to both potential tenant and landlord.  But the circumstances are a little out of the ordinary, too.  Both parties like what the other has to offer and both maintain optimism about how Maurice’s business would perform on at this location.  But uncertainty over the current pandemic conditions has both parties guessing at what the future holds. 

What we have here is an excellent location on one of the few truly pedestrian-intensive retail districts in Los Angeles and a retailer who has a proven track record of generating excellent sales in tourist-oriented retail districts.  But the landlord is nervous about percentage rent and the honest reporting of sales by a new tenant that they do not really know (very understandable) and the tenant is nervous about the pandemic’s impact on traffic and sales activity evidenced by the number of large vacancies on the street (also understandable.)  While we have not fully and finally agreed to terms, the issue is not really the rent but the expectation of sales given the current retail environment.  Maurice is prepared to take the space as-is and invest $40,000-$50,000 to decorate, illuminate, and stock the space, they have proposed a very generous percentage rent figure, and they have offered to open their books and discuss how sales would be honestly and accurately reported.  Bill has suggested a very reasonable possible fixed monthly rental that would be achievable if Maurice hits a fairly conservative sales target.  But we seem to be at an impasse – unless we can agree on the method of rental payment, we will part ways without a deal.

There may be creative ways to bridge the divide:

·        Start with a reduced fixed rent for a few months while the tenant gains sales momentum

·        Go with percentage rent for a few months and give both parties a right to cancel the lease if sales fall short of everyone’s goals.  If minimum sales targets are hit, the rent can convert to a fixed amount that is agreed upon up front.  The landlord gambles on expectations and will naturally be unhappy if the tenant terminates in this scenario but the tenant has much more at stake given their startup costs and would be reluctant to just walk away unless sales fall way short of their expectations. 

·        Some combination of these two, or…

Neither tenant or landlord have asked me to tender these ideas.  They spring from my imagination and are offered only as food for thought.  The decision to move the dialogue forward or to part ways (as friends, of course!) is up to the tenant and the landlord at this point. 

Thank you both for your time and sincere consideration.  I am standing by to help in any way I can.

I’m sorry to report that they remained immovable.  As the old saying goes, “You can lead a horse to water but you can’t make him drink.”  I fear they will both find themselves thirsty in an economic drought that does not appear to be near an end.

Nothing Gets Done Without A Good Plan

Often the CEO’s or business owner’s decision to move their offices is driven by the desire to save money, “right size” the company’s footprint, improve their image, or be in a location that better suits their staff and their customers.  These are all salient reasons to consider a move.  But often I find that the process shifts back into neutral when it gets to actually looking at other buildings and identifying a space that will really advance their goals.  What causes the drop off in determination to improve their workspace?  In almost every case, it is a lack of planning.  Space planning.

One of my long-term clients is a health care enterprise.  They provide clinical services but are developing new, high tech service delivery models.  Groundbreaking stuff.  They were recently staring at clear opportunities to expand in geographical submarkets that have proven to be very lucrative for them.  The CEO, the President and I had toured some buildings in two of these markets.  They were clearly motivated but the decision to move forward with offers and negotiations never seemed to come.  The issue became quite clear to me: they had several key operations staff members flinging in valuable input from the sidelines on what the facility needed to include but they had never all been in the same room with the C-suite executives to discuss it.  I needed to pull things together.

I arranged for a telephone meeting with the President and CEO and strongly suggested that we needed to find a designer with extensive medical office design experience to be a part of the growth team.  For my part, I promised to interview at least three and recommend one to meet with us and develop a template space plan.  They agreed.

We recently conducted that meeting and I was thrilled to have everyone in attendance that had key operational responsibility at their clinics and therefore an important contribution to make.  Not surprisingly, the conversation was animated but not just between the architect and the client.  There was lots off banter (and a little friendly arguing) between the members of the client’s staff.  You could almost hear the clang of sledge hammer against hot steel and things got worked out..  It was an incredibly constructive meeting.

The space plan that came out of that meeting was not the final product; indeed, everyone continued to contribute until all departments felt their needs were meet and better understood how to share resources and make their operations more efficient.  The final result, a well thought out space plan that had the buy in of everyone and a unified motivation to choose the building and get the clinic open.

Doctor, plan thyself!

A Rational Look At The Future Of Office Space

The shift in recent office space thinking has been profound.  But will the actual changes in how office space is planned and utilized be just as profound?  H Hendy, a highly respected Orange County, CA based planning and architecture firm recently put out a white paper on the look and effectiveness of a truly “blended” workforce with remote and location-based teams.  This is the most common sense view I have encountered, and I wanted to share some excerpts from their white paper.

“There is no prescriptive solution or one-size-fits-all answer in determining the amount of office space you will need or its configuration. Each organization will have a different solution depending on culture, leadership style and business objectives.”

The conversation can start with your real estate team including HR, operations and your outside, trusted real estate broker.  This time around though, have the team draft a skilled and knowledgeable planning firm like Hendy who can translate concepts to concrete plans

“While it may feel like we’ve been working from home for ages, we are still in the “honeymoon” phase. Remote working in the wake of a crisis has challenged many employees to rise to the occasion, and most of us are still on our best behavior. What remains to be seen is how our collective conduct will shift over the coming months, and how well leadership will react if out-of-sight turns into out-of-mind.”

What seems natural now about staff working from home may present problems and complications when human nature starts to reassert itself.

“We all have a basic human need for social interaction and connection. From an employee standpoint, this connectivity is often tied to their company’s vision, purpose and culture. In recent years, businesses have been prioritizing building a strong corporate culture through traditions that drive employee engagement, satisfaction and retention. From all-hands meetings to cornhole tournaments and potluck lunches, these efforts have largely been location dependent. With today’s new blend of onsite and remote workers, leaders will need to find new culture-driving solutions to maintain this momentum.”

Company culture, shared values, and a sense of teamwork does not naturally happen when we are physically separated by miles.  Company leaders may face profound challenges in inventing new ways of being and feeling together.   

Take heart – with enthusiasm and a forward thinking attitude, the future of your office is very exciting, indeed.

Popular Office Trend Predictions Might Be Off The Mark

I have expressed some skepticism about dire predictions about the end of office buildings as a result of the forced work-from-home conditions brought on by the COVID-19 pandemic.  I wanted to share an excerpt from a recent Globe Street.com article by Erika Morphy that articulates my own predictions.  In this article, Ms. Morphy debunks several myths about how the pandemic has changed commercial real estate.  The excerpt below focuses on office buildings:

The Myth

Office users will need less space as their employees continue to work from home. Office demand will lessen as fewer employees work full time in the office.

The Reality

This question of future office demand, of course, is being debated fiercely in the CRE community right now and there are good points to be made for both sides.  RCLCO principal Rick Pollack weighs in with an overlooked observation that Millennials and younger generations are having a harder time working at home as many are living in or sharing small apartments. There are also social aspects of an in-office experience that are difficult to replicate virtually.

Likewise from the employer perspective, Pollack said. “Onboarding new employees is more difficult to do virtually. There is also the cultural benefit of having people in the office and bottom line benefits of collaboration to consider,” he said.

For many companies this does not have to be an all-or-nothing proposition but even just shrinking square footage can come with problems, Pollack added. “Employees need somewhere to sit. The feedback on the hoteling or hot desking trend has not been positive. People are less productive when they don’t have an assigned desk.”

His conclusion: Office users will continue to use the same amount of space as they did before the pandemic. 

Another popular prediction is that office buildings need to become a no-touch, germ-free experience.Sensors for everything.No need to push buttons in an elevator or grab a handle to open a door.No need to dial a telephone in a conference room.And daily janitorial cleaning services performed to hospital standards.In the short term, this is indeed what office and building managers need to do to help keep the tenants and visitors safe.But after the pandemic passes, will these be permanent features of the modern office building?I wonder.

In Retail Today, Honor Will Be Rewarded

I got a call today from a small retailer in Las Vegas who was referred by a friend of his in San Francisco.  (How does this stuff happen?)  He has two businesses in an outlet mall on Las Vegas Blvd.  Foot traffic is down to a trickle and his sales are down by 60% since the pandemic.  Property management has been pressing him for past due July rent.  He wanted to strike a deal for a reduction but they weren’t offering any more relief than a rent deferral which just would have put him in a deeper hole.  He called me for advice.

I listened to his story: he had been a merchant in the center for 10 years, worked hard, merchandised well, and faithfully paid his rent without fail.  He couldn’t pay his rent now and wondered what his options were.  He felt like a deadbeat and hated it.

He is no deadbeat.  To the contrary, he is a model tenant.  I suggested he propose paying the landlord pure percentage rent – a set percentage of his gross monthly sales until mall traffic returned to normal.  This would keep his rent sustainable whether his sales went up or down. 

He appreciated my advice but wanted to know if I would write the letter for him because ‘I was the voice of authority.’  While I was flattered, I explained that getting a letter from an unknown third party – from Los Angeles, no less – would only aggravate the landlord.  I told him “the authority is you.  You know your business and have proven it month in and month out over ten years.  Tenants bigger and smaller than you are just quitting but you are fighting for your business.”  Not quite convinced that his words would have leverage, he said that his landlord was a big corporation.  “All the more reason they do see the value in a tenant who works hard and respects the lease contract.”

He is going to write the letter.  I suggested he start with a percentage that is a bit lower than what he can afford, just to leave him a little room to negotiate.  I’ll let you know how it goes for him.

The universe looks after good tenants.

Crisis = Opportunity

The economy is beginning to open up but it is a Coronavirus economy, not a post-Corona virus one.  Wearing masks outdoors is still required and social distancing is still the norm.  Most importantly, the fear of the virus continues to keep people away from potentially close contact.  Put another way, you can open up your business but will people come?  We still have a ways to go.

Once the majority does feel comfortable returning to their daily rounds, they will emerge into a badly dented economy.  But just like all recessions, this one will end.  And retailers that are recession-proof or are freshly capitalized will be presented with great opportunities. 

Pier One Imports, a 60 year old retail stalwart is going out of business and vacating its 900 stores across the country.  Their choice locations all boast prominent shopping center positioning and excellent storefront and pylon signage.  AT&T just announced the closure of 250 locations around the country as they see a slowdown resulting from lower customer demand of some of their legacy products, exacerbated by the pandemic shut down.  Many are high profile locations with attractive, modern interiors and again, excellent signage.

There are other opportunities.  The sudden economic vacuum created by the pandemic is likely to suffocate 20-30% of restaurants in California, knowledgeable observers say.  That is a lot of built out kitchen space and expensive interiors that will be there for the taking.  Independent restaurant closures are starting to appear.  No big chains have thrown in the towel just yet, but some most certainly will. I am already getting inquiries from restauranteurs looking to pounce.

Can you or your clients capitalize from these opportunities?  The old adage is most apropos: the early bird catches the worm.

Rethinking Office Buildings

In most large office markets, a tenant has a distinct choice: to house their business in a modern, Class A office building featuring dramatic common areas and amenities or to opt for an older building for the sake of lower rent. 

Historically, this was essentially a function of the tenant’s brand (translate: image), the needs of its hired talent, and whether the business was public facing; that is, visited often by their clients who might judge the business by the environment they choose.  About ten years ago, tenants started to focus on sustainability and their building’s carbon footprint.  A LEED (Leadership in Energy and Environmental Design) designation, whether it was silver, gold or platinum was a sought-after distinction.

As a result, since 2010, demand for four- and five-star offices has grown at four times the rate of that for three-star properties and 19 times the rate of that for one- and two-star offices, according to the commercial real estate data gatherer CoStar.  Newer buildings, which tend to have more natural light, modern air conditioning and heating systems that are more capable of removing pathogens from the air, more amenities, and more outdoor space, generally better facilitate a focus on health and wellness; indeed, because of newly heightened fears over the spread of communicable diseases, health and wellness is likely to be as important this decade as sustainability was last decade.

To this end, the International WELL Building Institute has launched a new standard to rate how well a building protects its occupants from the transmission of the novel coronavirus.  I can imagine many tenants insisting on this certification before signing a lease.

Going upscale or value used to be a matter of style and economics.  For some companies it may soon become a matter of life or death. 

The Reasons To Just Stay Put

Big, mission critical real estate decisions land on business decision makers’ desks every three to five years.  That is the time for soul searching.  Is our space meeting our business objectives?  Is it being utilized efficiently?  Are our employees happy about their work environment?  Are we paying too much?  Do we need to plan for growth?  Or, the thinking du jour: can we function as a team and a brand with less space?  Some businesses have a good relationship with a real estate broker who has advocated for them in the past and can brainstorm these issues continuously but most bury real estate issues until they cannot be ignored and then face an avalanche of analysis and decisions.

The decisions are more complicated today because of market turbulence that comes with a recession.  There are rare opportunities that appear in scary times, but that doesn’t remove the scary part.  Landlords see tenants fold up their tent and leave them with vacant space that they are very motivated to fill.  Those same landlords are even more motivated to keep the tenants they have.  The industry phrase is “tenant retention”.  Smart landlords follow that mantra every day with professional property management, responsiveness to tenant requests, and the curation of inviting common area amenities and programmed events.  But make no mistake, they are ready to negotiate attractive lease terms to keep you in their building.

As a tenant rep broker, my goal is to help the tenant make the decision that best suits their business objectives by showing them different buildings and sometimes even different submarkets. But I also realize that staying put and renewing their lease might be the best solution.  And you might be surprised to learn that everything is on the negotiating table with a renewal:

·        The rental rate can be negotiated down from the current level

·        Free rent concessions are on the table

·        Tenant improvements can be negotiated if some remodeling or refurbishing would make your space more functional and attractive.

The bottom line is that landlord’s need to offer existing tenants the same courtesy and incentives that they offer to a new tenant.  In fact, the wise ones take the attitude that existing tenants get more consideration because they have earned it.

The Smart Approach To Working Things Out With Your Landlord

This week I was engaged by two clients who wanted my advice about approaching their landlord for rent workouts during and after the COVID-19 lockdown.  One was a retail business that had to close their store but that still does a fair amount of online commerce.  The other is a salon that is just sitting on their thumbs – they can do nothing until the economy opens up again.

The financial workout strategy naturally looks different for each of these tenants but the principles listed below apply to all tenants that need to work things out with their landlord right now:

·        Treat the landlord like a business partner that you are striking a deal with or a bank you are hoping to get a loan from.  Certainly, financial hardship is what brought you to the table but mix some optimism into your negotiations.  Something like “this is my challenge today but with your assistance, I will be strong and profitable again soon.”

·        If you can pay any rent, pay something.  That accomplishes two things: 1) Your debt to the landlord will be less and therefore easier to pay off, and 2) It shows tremendous good faith and respect for the lease contract and the landlord.

·        Keep in mind that the challenging economic conditions will continue for some time after the economy reopens.  By most accounts, we will be coming out of the “freezer” of the lockdown into the “winter” of a recession.  Try to extend some level of rent relief several months into the future.  You will be glad you did.

And while we are on the subject of relief, many tenants may have some relief coming if they have business interruption insurance.  In fact, many tenants are required by their lease to carry such insurance.  However, many insurers are denying business interruption claims.  I have resources that can help you if your insurance company is pushing back.  I will be happy to point you to someone who can be a valuable advocate for you.

Is This A Good Time To Move Or Expand Your Business?

A crisis situation like the pandemic lockdown naturally triggers extreme caution and risk avoidance but it also presents opportunity for businesses that are well capitalized and in a position to act aggressively. Below is a brief look at the opportunities in the three key segments of commercial real estate and where the land mines might be buried.  

Retail

 Retail real estate really is a double-edged sword.  When we emerge from the stay at home and social distancing restrictions we will be in recession mode.  Consumer’s belts will remain tight for some time.  Just how long is impossible to predict given the very unusual circumstances that brought this recession on.  On the other hand, the shutdown will starve many business of the financial oxygen that they need to survive and they will not return, thereby thinning the competition.  This opportunity will be most present in the restaurant sector where some experts have estimated 33% of all restaurants in California will be wiped out.  Call it grave dancing…but an opportunity just the same. 

Industrial

This was the tightest market before the pandemic with microscopic vacancy rates of between 1%-2% throughout Southern California.  There will be some softening of this market as a result of the shutdown as non-essential manufacturers and warehousing and distribution businesses are not able to operate, let alone move and expand.  Working on the other side is the expansion of demand from online shopping supply chain operations.  I predict significantly more flexibility from landlords with respect to free rent and lease commencement timing but do not expect a big dip in rental rates.

Office

The office sector should be relatively resilient since office building users have been able for the most part to keep their employees busy and engaged at home.  Notwithstanding, many office landlords are as worried as retail landlords.  There is a lot of chatter about the revelation office tenants are having that they don’t need all of that expensive square footage after all and choosing to downsize their footprint or exiting the market altogether when their lease expires.  I believe this has been overstated but landlords are very eager to sign up tenants and are showing a willingness to be creative with rent rates.  Now is a great time for office tenants ready, willing, and able to make a space commitment.

To quote Warren Buffet, “When everyone is greedy, I panic.  When everyone is panicking, I am greedy.”  There is opportunity in precarious times.

The Wrong Lease Form Is A Dangerous Thing

To most commercial tenants, a lease contract is a 45 page monster with the deal points on page one, the signatures on the last page and mountains of legalese in between.  But there are different types of deal structures and an appropriate lease for each.  A retail lease addressing shopping center operating expense reimbursements and percentage rents based on sales will not be appropriate for an industrial tenant occupying a free-standing building.  That’s an easy call.  But sometimes there are problems with more nuanced contradictions.  It might be inappropriate language addressing maintenance responsibilities or the use of a very old lease form; in both cases, a sometimes lengthy lease addendum is needed to correct and clarify.  If that addendum is not worded carefully, the language contradictions may not be clarified or even be made worse.  Typically, the landlord provides the lease form so it is up to the tenant and their broker to look at the lease contract very closely.

Join me in the weeds for just a moment.  I just negotiated (more like “hammered out”) a warehouse lease at a multi-tenant property where the broker said the landlord covered all operating expenses but just charged the tenants a modest and reasonable common area maintenance fee.  But when the lease draft arrived, it was a “net” lease form that called for the pass through of all property expenses including reserves for replacement and structural building repairs.  There was a sentence in the addendum that set forth the tenant’s modest monthly charge but no language that refuted the language in the lease.  Furthermore, there were several other sections of the lease that alluded to the landlord’s maintenance responsibilities “subject to reimbursement as set forth in Section ‘X’” where said maintenance, such as roof repairs were included in the definition of common area maintenance.  As the tenant’s broker, I had to struggle with the other broker to make sure the proper language was crafted for the addendum to clarify exactly what costs the tenant was responsible for.

A good tenant representation broker will look at the lease with the eyes of a “tryer of fact”; that is a judge in Superior Court or arbitration.  I feel sorry for the other tenants in the project that didn’t read the lease closely or accepted the “don’t worry about it” assurances of the landlord’s broker and who find themselves in court fighting charges they were told they did not have to worry about. 

In this case, it was a hassle but the tenant signed a lease that accurately reflected the deal that was negotiated.

"Split Roll" Property Taxes Will Change Commercial Leases

Previously in “Lease Intelligence”, I prepared you, dear reader for the economic impact on business if the “split roll” property tax modification to Prop. 13 passes in November when it is expected to appear on the ballot.  To get a little insight on how the new guidelines would work, I spoke to Jonathan Marquit, a partner in the law offices of Burke & Marquit, a firm highly respected for its expertise in property tax matters. 

If passed, the proposed ballot proposition would affect all office, retail, and industrial properties starting in 2022.  According to Mr. Marquit’s knowledge of the drafting, the reassessment of qualifying commercial properties will be phased in over three years.  It is definitely worth noting that residential rental properties, regardless of size will not be reassessed under the proposed language.  This should come as a relief for apartment owners…and tenants! 

The drafters apparently realize that tenants in commercial properties will be impacted by this change because there would be an additional three-year delay before the county will start reassessing commercial properties where more than 50% of the property is occupied by qualifying small businesses.   This may apply to many office buildings, shopping centers, and multi-tenant industrial parks.  So if you are a small business planning on signing a lease this year with a lease term of five years or less, you may not have to prepare for a spike in property taxes until your next lease even if the “split roll” initiative passes in November. 

Should such a proposition be voted into law, no doubt real estate attorneys representing tenants will be crafting language that will attempt to mitigate the impact of sudden increases in property taxes.  And expect the assessor’s office to be overwhelmed by property tax appeals for years to come.

A good tenant representation broker will anticipate these issues and be an advocate for their clients.  If you are thinking about leasing commercial property, be sure you have one on your team!

Prop. 13 May Be Vanishing For Commercial Properties in California

It seems that every year, there is an attempt to implement a “split roll” for property taxes in California, leaving residential alone with the 2% maximum annual increase mandated by 1979’s Proposition 13 but erasing this cap for commercial property.  That it is being proposed once again is no surprise.  So why is everyone talking like it is really going to happen this year?  In a word…homelessness.

The homeless crisis has become so front and center in California that the case for jacking up property taxes may have finally reached the tipping point.  This is an issue that should be a cause of great concern to every commercial property owner and tenant. 

The politically convenient argument to soak “rich” commercial landlords to help fund a fix for homelessness and the overall affordable housing shortage in California is shortsighted, as it is the tenants at these properties that are going to take the hit.  Whether a lease is “triple net” or “full service gross”, increases in operating expenses are typically passed through to the tenant.  Think about it: if market forces have established rents around $4.00 per square foot with the possibility of only small, incremental increases in property taxes, the burden on tenants of a $.50 per square foot per month pass through charge resulting from a spike in property taxes will force asking base rents downward by that same $.50; otherwise, there will be an affordability crisis and a tidal wave of lease defaults.

This will be a mess.  Something has got to give.  In next month’s installment, I will examine how this is likely to play out in the rental market. 

Landlords and tenants, time to refill your Xanax prescription.

Let's Get Real About Tenant Improvements

There is a giant wild card in the economics of a commercial property lease that can easily derail a deal: tenant improvements.  In most instances, the tenant asks the landlord to make changes to the leased space prior to the lease commencement that can amount to a significant capital improvement on the landlord’s part.   Even for a small lease, these costs can easily climb into six figures.  What a lot of tenants fail to see is that this investment on the part of the landlord changes the character of the arrangement from a mere lease of space to more of a partnership.  It is enough for a landlord to agree to tenant significant tenant improvements but when the tenant’s financial statements don’t indicate impressive financial strength, the decision by the landlord will often be to pass on the deal.

A good commercial tenant rep broker can adjust the landlord’s perspective in a way that helps get over this hurdle.  In many deals, I emphasize the fact that many of the requested improvements add value to the building and make the property more valuable and the subject space more marketable for many years to come (and future tenants).  I call this “playing the long game”.   

I recently negotiated a deal for a tenant that wanted to move several walls in a small suite. The space was very inefficient with valuable space wasted on hallways and a couple of the windowless, interior offices that were too small to really be functional.  But it is crazy how the costs balloon when changes like this are planned.  There is a domino effect – walls impact the ceiling, the flooring, the HVAC (air conditioning system), and the lighting.  But by moving some walls, useless hallway space was converted into more area in those interior offices.  Windows were installed at the top of the walls in the interior offices to let in light.  Cabinets were relocated in the kitchen/break room area yielding enough space to put a small table and chairs for employees to take their breaks in the suite.  Now the landlord had a much more appealing suite for the market at large.  We just offered to lease it for the next five years.

I was able to get the landlord to see the tenant improvements as an investment in his building, not just in the tenant.  Everybody was happy with the outcome…and the landlord was quite happy for the income!