What Your Landlord Knows That You Don’t

A real estate lease is often one of the largest reoccurring fixed expenses for any business. Adding insult to injury, most leases provide for the rent to increase each and every year so that even if the starting rent was reasonable, it often ends up being above market by the end of the lease term. The situation is often worse for tenants who have remained in the same building and simply renewed the lease each time. Invariably, tenants in lease renewals pay higher rental rates and receive fewer economic concessions than tenants negotiating a new lease for vacant space. Does this mean that a landlord will give better terms to a new, untested company than to a loyal, repeat customer? Typically, yes unless you know how to navigate through those waters.

No one likes to relocate its business when the lease expires, unless it is absolutely necessary. Moving causes downtime, frustration, loss of income and time away from the core business. Most business owners feel this way, and landlords know it.

Lease-renewal negotiations are ostensibly about determining a fair price for space, or the “market rate.” In reality, there is no such thing as “market,” and real estate pricing is subject to dramatic swings depending on perceived leverage. Who has more leverage, the tenant or the landlord?

Let's take a look at a few points on how landlords evaluate their leverage when renewing a tenant's lease.

Statistics: Approximately 70% of all tenants renew or extend their lease on expiration, sometimes even sooner. Chances are that the existing tenant will renew.

Timeline crunch: Tenants who start negotiating too late often have no choice but to renew the lease. Waiting too long to evaluate relocation alternatives always places the tenant at an extreme disadvantage. If relocation is the preferred alternative, a typical 10,000 SF tenant needs to start planning 18 months before the scheduled lease expiration. Companies need to allow sufficient time to compute internal space projections, evaluate market options, visit desired properties, negotiate proposals and lease documents, obtain city permits and construct tenant improvements. Ultimately, when you are out of time, you are out of luck.

Telegraphing the punch: Business owners understand the concept of leverage, and yet, ironically, most companies initiate lease renewal negotiations by informing their landlord that they want to renew! Sacrificing their upper hand by essentially telling the landlord that there will be no competition from other buildings. When relocation is the preferred alternative, the tenant brings competition into play from various buildings and locations to find the best deal. Why not on renewals? What would you do if you wanted to relocate? Hire a real estate professional. The message is clear: every time your lease comes up for renewal you should treat it as an opportunity to consider your relocation alternatives in earnest.

Unrepresented: Some tenants engage a real estate firm when they plan to relocate their business, but not when renewing their office lease. This saves money for the landlord in two ways—they won’t have to pay a real estate commission, and they won’t have to compete with other vacancies in the market. If they tell you they are willing to share in the commission savings with you, beware. The commission savings are a small percentage of the higher rent that they are hoping to extract by negotiating with you in isolation. In reality, most landlords will pay themselves if there is no outside representative.

Knowledge: Landlords lease space day in and day out. They are well-advised, it is their primary business and it is how they make money. Conversely, most tenants are not in the real estate business and carry out this process once every three, five or ten years. It is not their core business. Consider it a pro-am match up if you plan on handling this yourself.

Bluffing: Is the tenant in the market considering and negotiating on relocation alternatives, or is all this talk just a smoke screen? Never bluff. The stakes are too high.

Renewal option: Considering exercising your renewal option? Think again—it could cost you more in rent. In residential real estate, “comps” are useful for market value, but in commercial leases, they often lead to overpayment. Factors like lease terms, tenant improvements and parking skew the data in landlords’ favor, plus comps reflect past rates when rents were higher. With the market trending down, you’ll likely get a better deal by not exercising your renewal option.

Maximizing a tenant's leverage in lease negotiations is part art and part science. Understanding the list in this article is a good start. Many other factors about the tenant's existing office space and building should be understood and evaluated, such as current building cash flow and future rental projections, tenant-improvement costs (to improve the space for a new tenant), downtime for vacancy and risk with a replacement tenant. Trust your real estate partner to help you make the most of every lease renewal, enabling you to focus your energy on your core business!

Anna Kaplan Rhonda Sher Cale Miller