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Weekly UpdatesIn lease negotiations, we strategize how to negotiate the best possible deal for our client--the landlord. When the market is strong, we focus all our attention on the needs and concerns of our client, but often lose sight of the concerns of our tenants. In a robust economy, tenants have limited options and are likely to accept our offer with little negotiation. However, in a weak economy or recession, it is in the best interest of our client to consider each tenant's concerns and needs.
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Office tenants are concerned with low occupancy costs and relocation costs, while retail tenants are concerned with low occupancy costs and the ability to close their store if it does not become profitable. These issues are counter to what the landlord is able to achieve in a strong market.
In today's weak economy and depressed real estate market, property managers and leasing agents must be prepared for some of the toughest negotiations in decades. As the property manager or leasing agent, you will be required to negotiate several lease provisions that are onerous to the landlord but necessary to complete the lease transaction. The provisions must be skillfully negotiated to mitigate their impact on the cash flow and value of the property.
NEGOTIATING WITH OFFICE TENANTS
Office tenants know that in a weak real estate market they can negotiate several issues that can save them thousands of dollars. The first issue is the base rent. The best way you can be prepared to negotiate the rent is to have a complete understanding of the market and competing buildings. This can be achieved by periodically conducting a market survey which will provide rental and vacancy data needed to determine the market range of rents for competing buildings. You can use this data to compare the subject building to its competition, and then recommend the rents and concessions for the subject building.
Next, you must know the landlord's "bottom line," or how low a rent the landlord will accept. This will be dependent on what other concessions may be offered. When you meet with the property owner to review and discuss the market survey and your recommended rental rates for the building, he or she will make the final determination for both the rental rates and the parameters of lease deals.
One component of negotiating the base rent is rent step-ups, which are increases to the base rent during the term of the lease. You and the property owner will decide if there will be rent step-ups, and if so, how much and how often.
Free rent for a month or several months of a lease term is the first concession a tenant is likely to ask for. In a typical market, free rent is not usually offered. When it is, it is for a limited period of time. You need to determine how much free rent will be granted and if it will be provided at the beginning of the lease term or spread out over the lease term. In most cases, free rent is provided at the beginning of the lease so it is "burned off as soon as possible.
In a weak economy, many buildings may have cash flow challenges that prevent the landlord from giving several months of free rent in the first year. In hard times, a common concession is to spread the free rent over the lease term by offering one month of free rent at the beginning of each lease year, or spreading the free rent equally over each lease year.
The tenant's next request is likely to be for a cap on the annual percentage increase of the pass-through expenses. If this concession must be offered, you will need to negotiate the maximum percentage rate increase and determine whether the non-controllable expenses, such as real estate taxes and snow removal, are capped. The tenant is also likely to ask for above standard tenant improvements. Again, you must do your homework and review your market survey to find out what the market is offering in tenant improvements. Because tenant improvements are very expensive, the base rent may be tied to the amount of tenant improvements provided.
Moving is expensive for tenants and disruptive to their businesses. Most office tenants do not need to relocate, but during a weak real estate market, some building owners will present very attractive offers that encourage tenants to move to their buildings. Tenants may be offered a moving allowance or the entire cost to move, for example. Costs for moving a tenant can add up quickly. They often include moving equipment and furniture, as well as removing wiring in the space the tenant is moving out of, installing computer and phone systems and ancillary costs. It is important to get cost estimates before negotiating any moving allowance.
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The sophisticated tenant and knowledgeable tenant representative will also negotiate for the reimbursement of the ancillary cost of moving, which includes new stationery and business cards, notifications to the tenant's customers, free rent while setting up the new office and more.
NEGOTIATING WITH RETAIL TENANTS
Retail tenants have the same concerns about occupancy cost as office tenants, but they are also concerned about operating in a location that isn't profitable--or operating at a loss. To help alleviate these concerns, some retail tenants will negotiate for a tenant improvement and equipment allowance. This is a fixed dollar amount which can be a few thousand dollars for a small retailer, to hundreds of thousands of dollars for a very successful retailer or restaurant chain.
In addition to negotiating the base rent, rent step-ups and pass-through charges, the retail tenant will often attempt to negotiate a percentage rent provision as well. As the property manager, you need to determine if the tenant's sales would ever achieve the level to pay percentage rent. You can determine this by reviewing the sales trends of a prospect's other stores and comparing the tenant's sales breakpoint to the national sales averages for this category of retailing, found in the Urban Land Institute's bi-annual publication, Dollars & Cents of Shopping Centers.
If the shopping center has similar retailers or restaurants, their sales can be compared to the prospective tenant's breakpoint. The sales breakpoint is the amount of annual sales the tenant must generate before it starts to pay percentage rent. If this is not likely, you may be able to acquiesce and use it to gain a concession from the tenant. If the percentage rent provision is negotiated, the tenant is likely to request a lower percentage rate and possibly a high artificial breakpoint. An artificially high breakpoint is a sales amount above the natural sales breakpoint. The natural sales breakpoint is determined by dividing the tenant's percentage rate into its annual rent. The resulting number is the natural breakpoint and the tenant pays percentage rent on all sales above the natural breakpoint. If the breakpoint is negotiated higher than the natural breakpoint, the tenant pays less percentage rent.
Again, you should determine what the tenant's sales are likely to be and how much this request will cost the landlord in lost percentage rent. Using the tenant's average sales in its other location is a good starting point to determine what its sales would be after a start-up period. The tenant may negotiate for a percentage rent-only lease and no base rent. If this is agreed to, you should then negotiate the percentage rate a couple of points higher. Another counter would be to make the lease percentage rent only for the first year or two, and then have it revert to a base rent.
Retailers may also negotiate to cancel their lease if their sales are below their projections. This is an added concern for retailers who are leasing space in a weak shopping center or mall, or when the economy is in trouble. The better retailers may negotiate for the right to lease cancellation. You should resist giving this right, but if it becomes a deal breaker for a good retailer, the cancellation right should be negotiated to lessen the chance the tenant will cancel the lease. First, you need to make sure the lease cannot be cancelled unless the retailer's sales do not exceed a specific volume during the third calendar year of the lease. The sales volume should be a realistic number and no less than the average sales of the tenant's other stores after three years of operations, and no less than the national averages.
The national average sales for dozens of types of retailers are published in Dollars & Cents of Shopping Centers. The retailer must have at lease three years, including three holiday seasons, to generate these sales. he cancellation is a one-time right during January, following the third calendar lease year. The tenant must also give the landlord a 120-day notice of cancellation. It is not likely the tenant will pay a cancellation fee, but it is good to ask for one.
The retailer may also ask for a co-tenancy provision as a cancellation right. This allows the tenant to cancel a lease if a specific anchor tenant goes out of business, or the occupancy of a shopping center drops below a specific percentage. This is another provision you should not agree to because it can create a domino effect on losing tenants. If the property owner must agree to this provision, a counter is to have the tenant's lease convert to percentage rent only during the time the anchor tenant's space is vacant. Just because one anchor tenant closes does not mean the other retailer's sales will decline. You can also create a condition that says a tenant cannot exercise its rights under the co-tenancy provision unless its sales decline more than 10 percent.
In a weak market, tenants will ask for the moon. As the property manager or leasing agent, you must be prepared to respond to that request. The reality is that concessions are needed to make most lease deals work in a weak economy and a soft real estate market. You should develop, with your building owner, a lease negotiation strategy that includes the landlord's response, along with fall- back positions to all the lease provisions the tenant is likely to negotiate. You also need to determine the cost of each concession, and whether it is to be paid up front or will be a cost over the term of the lease. Knowing the cost to the landlord of each negotiated lease provision will enable you to negotiate the best possible deal.
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