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.

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.

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.

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.

Speaking The Landlord's Language

The key to every commercial real estate lease is constructing an economic framework that works for both the tenant (my client) and the landlord.  Most tenants envision this simply as negotiating the lowest rental rate that the landlord can tolerate.   It is much more than that.

The other major capital expenditure after rent is the cost of remodeling and refurbishing the leased premises, commonly referred to as tenant improvements, or T.I.s.  This is the financial weight that breaks down most lease deals.  It is understandable that most tenants do not do not have much experience working out these issues.  But it always surprises me to find so many landlords lacking the imagination to creatively solve these problems.

The problem, when it arises, is typically that the cost to construct what the tenant needs is more than the landlord is prepared to spend.   This is where an experienced tenant rep broker’s understanding of the landlord’s investment perspective helps the most.  After all, return on investment is how they look at real estate in the first place! 

I recently had a situation where an office building landlord was quite stubborn about bridging the T.I. gap.  First of all, he was unwilling to fund the T.I.s outright but gave the tenant a free rent concession and told them to do the construction themselves.  But the concession offered was only half of the tenant’s cost.  When I attempted to bridge the gap with a request of additional T.I.s the landlord offered one more month -- $1.50/square foot --  for an additional $.10/s.f. on the rent for the three year term.  Apparently, he failed to do the math: 36 months x $.10 is $3.60.  Pulling out my financial calculator that comes to…an annual interest rate of 60%.  Non-starter.  So I patiently spelled out a loan amortizing three additional months of free rent at 6% interest that came to $.12 per square foot per month.  The landlord agreed to the deal and the lease got signed.  (Yes, I know many of you are thinking, where the heck can you rent office space for $1.50 per square foot?  Give me a call and I’ll tell you!)

The framework for a lease deal requires many beams and a good real estate broker to serve as an expert welder.

A Question Of Critical Nuances

Last month we addressed how to bridge the gap between the capital required to remodel and refurbish leased premises and the how much of that cost the landlord is willing to fund.  But there are nuances within those costs that, if overlooked, could turn out to be very costly to the tenant.

I recently negotiated an office lease deal that involved tenant improvements (T.I.s) well above what the landlord saw fit to pay and a tight move-in deadline on top of that.  The brokers on the deal and this sophisticated landlord put their heads together to see where cost and time savings could be found (referred in the trade as “value engineering”)  The landlord indicated that he would have his contractor do the improvements without pulling permits with the City which would save time and trouble.  Candidly, this “under the radar” approach is taken quite often if the improvements do not involve extensive structural, electrical, or plumbing improvements.  But there are risks.

As we were drafting the language surrounding the landlord’s T.I. allowance, I made sure that the tenant’s exposure to costs over the allowance were limited to “hard” construction costs – the cost of the general contractor’s labor and materials.  All “soft” costs – architecture, engineering and other fees – would be 100% the landlord’s responsibility. 

Guess what happened?  A City building inspector on his rounds spotted a large dumpster behind the building, went upstairs to take a look, and promptly slapped a stop notice on the door frame of the suite, halting construction on the spot.  Busted!  Now formal plans had to be drawn and submitted for plan check, and the cost of permits, and penalties would be incurred.  Because of the language I had worked into the lease, the tenant was spared many thousands of dollars of unforeseen additional cost.  The delay to the completion date was the only problem they had to deal with.

The moral of the story?Don’t let your clients, friends or family membersnegotiate a commercial real estate lease without having an experienced tenant rep broker at their side!

Adding Real Value for the Tenant

I get to brag every now and then.

I just wrapped up negotiations for a lease where I represented a residential real estate brokerage office.  We found the ideal building on a high profile corner in West Los Angeles that was right in the middle of their primary “farming” area – exactly where the company wanted to be.  There was only one thing missing and it was a big thing: exterior signage that would promote their brand to a high volume of traffic on the two busy intersecting streets that passed in front of the building. 

The building already had two large tenant signs on the exterior walls and the landlord deemed this was their limit.  But there was a small, innocuous address monument sitting in the landscaping on the corner.  It was the perfect place for a monument sign but in the 20 years the building had been standing there, the ownership was never motivated to erect one.   That is, until Aaron Weiner came along, wielding the colossal leverage of a 2,000 square foot tenant.  (Yes, that’s a little sarcasm!)  And so I pressed for an opportunity to create a benefit for my tenant far more valuable than grinding for a little lower rent rate.

I enlisted the support and cooperation of the listing broker.  Together, we convinced the landlord to engage a sign contractor and develop a design.  I demonstrated to the landlord how he could recover 100% of the cost of the sign from the tenants who appeared on it.   When they presented the design to the tenants in the building, the proposition was well received and several positions on the sign went very quickly.  But the landlord was slightly concerned about the two slots that remained.  So I explained how those empty positions on the monument would  serve as a magnet to attract new tenants!  That sealed the deal.

Some of the credit goes to the landlord who was intelligent enough to embrace the benefits of the sign.  But I had the satisfaction of scoring an unlikely victory for my client and creating long term value for the landlord. 

Unfortunately, I was unable to convince the owner to put my name on the sign.  (More sarcasm!)

The Unavoidable Issue Of Tenant Creditworthiness

Recently, I was working with a tenant whose entertainment-based business was doubling year over year.  He needed to move out of his 4,000 square foot space and find something around 12,000 square feet to facilitate contracts that were coming down the pike from major entertainment companies and studios. 

We found the perfect building in the perfect location and lobbed a reasonable offer in to the landlord.  We were making progress negotiating terms but when the landlord looked at the tenant’s financials we hit a snag; well, more than a snag – a brick wall.  The landlord was concerned over the tenant taking on rent that was triple what he was currently paying and demanded a huge security deposit to offset what he perceived as the risk in leasing his building to my client.  The up-front cash demand killed the deal. 

My client was extremely disappointed.  This is understandable but I explained to him that I have successfully navigated negotiations for tenants facing greater challenges:

• I had a client who had a recent bankruptcy on their record that would have cut off discussions with many landlords.  I coached them to present a story that explained how their recent financial troubles were unrelated to the business that would be operating in the space and paying rent.  We got over the hump and negotiated a very fair deal for them.
• I had just finished negotiations on a 10 year lease of a surface parking lot in an upscale Westside commercial district for a client who was an immigrant from south Asia and who had just become a citizen of the U.S.  While he had several years of experience in the parking lot management industry, he didn’t have two nickels to rub together.  We got the deal done – with a sophisticated landlord, no less – without providing any financial statements whatsoever.  The tenant did have to pay an enhanced security deposit but I negotiated terms that will get most of it refunded to him after the first couple of years of the lease.

Tenants with less than stellar financials will occasionally encounter a very skittish property owner but there are others out there that will be much more open to leasing to a promising business.  

A good tenant representation broker can help write the story that will end in “happily ever after”.    

Sometimes The Real Estate Is Only One Leg Of The Race

When you are negotiating to purchase a business part and parcel to accelerate your growth, expand your business range, or increase your market share, there are two critical facets of a sound economic deal: the valuation of the business and the cost related to the real estate. 

When the real estate is for sale with the business, establishing the intrinsic value of the real estate is more or less a function of two standard appraisal practices: analyzing value by looking at comparative sales, and by looking through the lens of the highest and best use of the property.  

It becomes a bit trickier when the real estate is retained by the seller and leased to the buyer or is leased in the first place.  The rental costs of the real estate have a huge impact on the net income projections of the business and cannot be negotiated separately from the acquisition of the business enterprise.  Doing so puts untenable pressure on the dealings for the second piece and negotiations could breakdown altogether.  The two major financial pieces must be on the table at the same time. 

I am typically involved in the buy side and recommend to my clients that they let the business seller express their preference of whether they want to get the best possible pricing on the business or on the real estate.  Then everyone involved knows what part we will be negotiating and understands how the two are linked together.

Exercise both legs simultaneously or else you will be limping – or worse, hopping – toward your future success.

Ask Correctly and Ye Are Likely To Receive

Even the best businesses run into cash flow problems.  There are often sources of internal capital that are available to cover these dry spells including cash reserves and credit lines.  When those are not available, often the biggest help can come from the landlord the business sends their rent check to every month. 

Inexplicably, most tenants assume the fetal position when dealing with the landlord.  Think of the term – the “lord of the land.”  It’s amazing that this medieval concept has survived to the present day.  In my previous life as a property manager I often dealt with tenants begging for relief and mercy from the landlord.  Such a misguided approach to seeking financial assistance rarely got the tenant what they were asking for or what their business really needed. 

A tenant needs to approach the relationship with their landlord from a modern perspective; that is, two complimentary businesses in a contractual partnership.  When you view things in this light, the request for rent relief becomes a simple business transaction: an investment by the landlord in the tenant’s business.  Think about it: when a business solicits investors for money, they sell the positive prospects for success.  The tenant needs to characterize the trouble they are facing as a temporary setback caused by market conditions or perhaps a business miscalculation on their part.  In any event, their pitch to the landlord needs to emphasize the fact that with some help, the problem can be neutralized or reversed and that the ultimate result will be a stronger tenant who will be better able to fulfill their contract with the landlord.  

This strategy works when you get sound guidance from a good real estate broker and advocate.  I recently coached a client of mine and helped them get $60,000 of rent relief.  In addition to helping them word the request using the proper, positive tone, I advised them to propose repayment terms that would allow them to pay back the balance due ahead of schedule and leave the landlord feeling like they had made an excellent investment. 

Beats begging, doesn’t it?

Search For Answers

I wish I could tell you I have all the answers but I do not.  (Alert the media!)  Grave concerns perceived by my clients show up during lease and purchase negotiations that I cannot resolve with persuasion or market knowledge.  Do you have kids?  Ever notice how your child will take an outsiders advice more seriously than yours?  OK, now we’re on the same page.

When negotiations get into crunch mode and the deal is on the line, the tenant may begin to wonder whether their broker’s advice is offered in their best interests or in the interest of closing a deal and collecting a commission.  That is when I often call in outside experts that can provide facts and perspective that will lead to a wise decision by the tenant that really does support their objectives.  These outside resources include attorneys, accountants, bankers, architects, contractors, and entitlement consultants.   And as a tenant advocate, I have a large stable of them.

In one recent deal, my client was negotiating to purchase a property for development in a , shall we say,  “controversial” submarket from a seller who had been pursuing entitlements to do his own development.  My client maintained what I thought was an overly pessimistic opinion of whether and when the entitlements could be secured.  The parties were at an impasse and talks stalled.  I knew that arguing my case would only have been self-serving.  So I got permission from the seller to have his entitlement consultant meet with my client.  The informed intelligence of this consultant answered my client’s questions, put his mind at ease, and got the negotiations moving forward again.

A good tenant broker will search for clarity…and go to the ends of the Earth to find it.

The New Tenant Creditworthiness Game

Landlords will forever insist on seeing financial statements before finalizing a lease deal with a tenant, whether they are a small business or a publicly traded company.  And they should.  But what does a tenant do if their ship has been tossed – and perhaps badly damaged – in the hurricane of the recent, extended recession?  And, I mean, who amongst us didn’t suffer?

I have represented tenants who, in some instances were looking to downsize for the sake of their very survival.  It was unlikely their financial statements were going to inspire many landlords to spontaneously break into song.  So, did this tenant need to resign themselves to rejection?  Absolutely not.

Landlords suffer a parallel fate as their struggling tenants.  They naturally prefer tenants that have capital reserves that will better insure that their rent will arrive in the mail every month.  But in challenging economic times they are forced to look beyond the numbers, and good brokers can coach their tenant clients how to tell their story in a persuasive way.   It requires taking the time to learn about the tenant’s business and ask some difficult questions to get to the truth.

I recently negotiated a lease for a client – we’ll call him Stuart – who is a prominent, established interior designer for large homes and hotels.  His industry was decimated by the recession and the very fact that he survived at all was a testimonial to his reputation and perseverance.  We presented the landlord with a couple of years of personal tax returns.  This gave the landlord the facts.  They are what they are.  Starting off with honesty is always the best policy.  But what we submitted with the numbers was Stuart’s story: his 30 year history in the business, his impressive resume of clients worldwide, and his nimble resizing of the company to insure its continued viability.  We worked together on the story so it hit what I knew from experience would be a landlord’s hot buttons .  We proceeded to final lease documents without a single question from the landlord.

The facts + a success story that harkens back to better times = the new creditworthiness. 

Tenant Improvement Allowance: It's Not Just How Much But When

How does it feel when you negotiate $100,000 of landlord-funded tenant improvements in your lease, you use $75,000 to get the premises ready for your occupancy, and then find out there isn’t any allowance left a year later when you have to replace the broken down air conditioning unit on the roof?  You just got the shaft, dear tenant…twice!

Most leases are drafted by the landlord and so are skewed heavily in their favor.  Language in the “Work Letter”  – the lease addendum that addresses tenant improvement construction –  typically states that the landlord allowance is for construction and improvements to the premises that relate to the initial space plan and that are performed prior to the lease commencement date; in other words, “use it” for only this work and within this time frame “or lose it”.  Most tenants and many inexperienced or oblivious real estate brokers don’t give this much thought.  The tragedy is that most landlords don’t even pay close attention to this detail; that is, until the tenant surprises them down the road with a request for funding for subsequent improvements, and then they turn the tenant down flat.

I’m giving away a valuable trade secret here, so pay attention!  Try deleting the language that puts time restraints – direct or implied – on the use of tenant improvement dollars provided by the landlord.  It is amazing how infrequently I find landlords rejecting this change to the lease.  The poor soul at the top of this article could have been $25,000 to the better if his broker had done this for him!

There are other improvements that the typical Work Letter states cannot be paid for by the landlord’s tenant improvement allowance, including furniture, fixtures and telecom systems.  These too can be negotiated in your favor by a savvy, experienced broker.

 A good tenant advocate knows that everything in your lease document is negotiable

The Myth of "No Free Rent"

Did you sign a lease only to feel your stomach turn when find out that you left several months of free rent on the table?

Tenants are understandably intimidated by improving market conditions.  Space is actually getting leased up again.  Rents are slowly climbing out of the doldrums of the last recession.   In a few  submarkets they are rocketing up.  Tenants can be intimidated by pronouncements of landlord rep brokers that “we have offers on the table”, “the space won’t last long”, “the premises are being leased ‘as-is’”, and that “the landlord is not offering any rent concessions.”

Those pesky brokers – are they lying?  No – they are just doing their job; that is, to gain the best advantage of improving market conditions for their clients, the building owners.  They are professional salespeople.  And the best ones are great salespeople.  Most tenants are blinded to the fact that they need an advocate who understands the landlord’s position in the market and who isn’t cowed by the pronouncements of their brokers.  Consider: When two professional brokers get down to negotiating a lease, the sales-y rhetoric evaporates and is replaced with the language of the deal.

Let me tell you: in all but the most in-demand micro-markets and neighborhoods, rent concessions are still on the table.  Quality tenants are still highly valued.  There are many concealed flex points in the economics of the lease that allow a good agent to tailor the deal to your specific needs.  

It is wise to have an agent who knows whether that building you really like is really as hot as the owner’s broker would like you to believe it is. 

Making Landlords Love Free Rent

I recently negotiated a lease for a retail tenant with twelve months of free rent up front.  You might be wondering what I slipped into the landlord’s coffee before we started negotiating but that wasn’t the case at all.  The key to negotiating free rent was not to argue the tenant’s financial weakness and need but rather their strength and intelligence. 

As we have all observed, the most vulnerable time for a retail business is in its first couple of years.  In most retail leasing situations, the tenant invests a significant amount of capital into the premises for FF&E, or furniture, fixtures and equipment.  And then there is the investment in marketing and advertising that is absolutely necessary to draw customer traffic to their new location.  As the tenant’s broker, I confidently touted the strength of the client’s business based on its one other established location and convinced the landlord that by allowing the tenant to preserve his operating capital for marketing and promotions, he would be giving them enough “runway” to get the business off to a successful start, greatly improving their chances of enjoying a reliable rent stream over the long term.  It didn’t hurt that this particular landlord had just cancelled a lease for a restaurant tenant that never even opened because they ran out of capital – I researched the situation and worked it to my client’s advantage.

An experienced tenant advocate knows that the objective is not a generic “good deal”, but a deal geared to the tenant’s long term success.