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.

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.

Time is Money With Commercial Real Estate Leases

Common economic sense guides the framework of most commercial real estate leases.  And a successful negotiation takes into account the financial objectives of both the tenant and the landlord.

For both parties, the primary economic factors are the rental rate, the free rent concession (if any), and the investment of capital by one party or the other in the form of tenant improvements.   There are some capital expenditures that just impact one of the parties: for the landlord, it is lease commissions paid to the brokers responsible for putting the deal together.  For the tenant, it is the fixturization of the space.

One key factor that is not technically considered economic is the length of the lease term.  In most circumstances, the landlord sees more value in a longer term contract over a shorter one and the tenant often prefers the shorter term to avoid being stuck in a lease given the uncertainty of the future.  An effective tenant representation broker knows how to keep the landlord’s value proposition in mind when guiding the tenant toward a deal tailored to their business needs:

• Does the tenant need lots of free rent for a long buildout period for a retail space?  A longer lease term may appeal to the landlord and soften his resolve.   

• Does the tenant need the landlord’s capital to build out office space to the tenant’s specifications?  Here again, a longer term means a longer amortization period for the capital investment and helps the landlord rationalize the expenditure.

• The absence of free rent or capital expenditures in a deal for a space that the tenant can put to use in its current condition reciprocally opens the door to the possibility of a short term lease.

While the push and pull of the economic forces outlined above are evident in just about all lease situations, the nuances of needs and circumstances present many complications.  It’s like a football game – a successful team adjusts their game plan for each opponent.   

When it’s time to make a game changing real estate decision, bring in an experienced quarterback to help strategize the drive to the goal line.

The Hidden Value In A Lease Option To Renew

The lease option is one of the most common add-ons to a commercial lease and is more often than not granted by the landlord when asked for.  When the landlord drafts the lease they drop in their standard lease rider or amendment language.  There it is: the tenant may renew the lease for five years (typically) so long as they give the landlord advance written notice by a defined deadline.  End of story. 

No…it isn’t!  Also commonly found in option language is a clause that states that the option is “personal” to the party who signed the lease and cannot be transferred.  Most tenants don’t give much consideration to the possibility of assigning their lease down the road and so they don’t give this much thought.  But consider the following real situation I just negotiated for a retail service business in West Hollywood:

The shop space is in a burgeoning retail district in town that is experiencing exploding rents just a block to the west.  First, we were able to negotiate a set rent for the option period, so we avoided surprises that can come with a “fair market rent” reset.  Then I asked to delete the sentence that said that the extension option was not transferrable.  The landlord did not hold a strong position on this language – it has just been in their leases since time immemorial – and so he agreed to the change.

Now let’s project into the future.  The tenant decides for whatever reason to sell the business a few years down the line.  Let’s say there are three years left on the lease.  The high rents from a block over have migrated into my client’s neighborhood making the rent we negotiated well below market.  Having eight years of below market rent (three remaining on the original term plus five in the option) versus just three could positively impact the value of this business by $500,000.

Now that’s keeping your options open.

For The Best Results, You Need A Great Coach

I imagine many of the readers of Lease Intelligence play golf, tennis, or another competitive sport.  The joy of getting better over time is the great allures of playing sports.  But certainly, there are aspects of your game that you would love to improve.  The difficulty of breaking through these performance barriers is a trade-off frustration.

Imagine if you had a dedicated, professional coach watching your every move.  Do you think your performance would be better?  And what if that professional coach was available at no cost – completely free to you.  Would you be all over that opportunity?

That is what an experienced tenant representation broker is – your business’ free real estate coach.

My friends, tenants are getting “the shaft” every day.  Many of you have heard me chant this over and over again.   Sometimes, they get it from the landlord.  Candidly, a lot of the time it’s self-inflicted – they don’t know what they don’t know!  Yet they go it alone, making mission-critical real estate decisions and negotiating a lease without the help of a good coach – their advocate – making sure that lease is well negotiated and tailored to their unique needs.

This is how we approach things at The Tenant Group – it is why the company was formed in the first place and why I joined their ranks last month.  Listen, we enjoy what we do.  It’s fulfilling to us.  It is our passion.  What looks like a minefield to the tenant is a road map to us.  

You call me…invite me over to your office…we sit down and talk.  We put your objectives and priorities on the table and we see if we’re a good fit.  I mean, my clients love me but I’m not right for everybody!  But in any event, don’t go it alone.  You really do need an advocate when you’re looking to lease or buy commercial real estate

The Best Way To Negotiate The Base Year For Operating Expenses

In a recent post, I reminded all tenants to pay close attention to landlord communications about operating expenses.  Today, I am going to share with you one very easy (and almost always successful) negotiating tip that will definitely save you money.

If your lease is Full Service Gross (typical for office buildings) or Modified Gross (office buildings and industrial properties), certain expenses are passed through to you only to the extent they increase over the cost incurred by the landlord in the first year or “Base Year”.  The Base Year is usually defined as the calendar year in which your lease commences.  No problem so far. 

The lease goes on to say that you will be billed for increases in those expenses in subsequent years.  That’s logical…but look out.  Let’s say your lease commenced in July of 2015.  Chances are that would make 2015 your base year and allow the landlord to start billing  your share of operating expense increases on January 1, 2016.  What was touted as a base “year” only really got you six months of protection. 

How to avoid getting the shaft?  Simply have your broker-advocate insist on lease language that says you will not be responsible for any pass through costs for the first 12 months of the lease term.  That right there would likely save a class A office building tenant $.45 per square foot over that six month period.  If your leased space is 10,000 square feet, that’s $4,500.00, thank you very much.  (Call or email me for a quick explanation of the math.)

A penny saved in smart lease negotiations is a penny earned for your business.

Operating Expenses Can Be a Minefield

If you are a tenant at a property with a single building, your share of operating expenses and property taxes is an easy concept to understand.   But in most multi-tenant office buildings, leases are structured as “Full Service Gross” where the rent includes the tenant’s share of operating expenses for the first year, or “base year” of the lease; in subsequent years, the tenant is charged only for increases over those base year expenses.  Are you confused already?  It’s not unusual.  All the more reason to have a knowledgeable advocate in your corner. 

The calculation of these increases is where tenants can be cheated.  For instance, what if you leased space in a building that was 50% occupied.  Would the building’s electricity expenses be lower that year than in a future year when the building is 85% occupied?  Absolutely yes.   Let’s do a little quick math.  If you occupied 5% of the building and the base year electricity cost was $25,000, 5% would be $1,250.  In that future year with the occupancy up to 85%, the electricity cost is $42,500 and your share is $2,125.  Therefore, your share of the increase over the base year is $875. 

But wait.  Look at a utility bill in each of the two years.  The utility’s rate per kilowatt hour has not changed!  If this doesn’t seem fair, you are right – you are being ripped off!  A well written lease should state that occupancy-sensitive operating expenses (like utilities and janitorial services) for the base year and all future years must be adjusted to reflect an occupancy constant like 90% or 95%.  If that rule is in the lease and properly adhered to, the increase of electricity costs over the base year charged to you in the scenario above would be zero.

A good real estate broker with some property management experience will have your back.  Be sure you have one looking over your shoulder.   It could save you an arm and a leg.