By Stephen A. Cross, CCIM
Real estate is generally the second greatest operating expense of a business after employee salaries and benefits. It’s also the area where most business owners overspend, generally without being aware of how much they could have saved to lease the same space, in the same condition and in the same building. The following discussion focuses on some of the variables common to most commercial leases. Taken together they can serve to significantly lower the effective rental rate and reduce the overall costs of occupancy.
Rental rate. Advertised rates are typically 5 to 15 percent higher than the landlord will accept. Be mindful that, as in any high-stakes negotiation, landlords seldom start with their bottom line price or terms. When discussing price with listing agents, always refer to the advertised rental rate as the “asking” rate, inferring that price is negotiable.
Escalations. Minimize rental rate escalations by fixing any increase to a nominal amount and postponing them as long as possible.
Free (abated) rent. Negotiate one month of free rent for every year of the transaction (an 8.33 percent discount) and never agree to amortize “free” rent over the lease term. In that regard, if no incentives come with a longer term, I suggest opting for the shortest term possible. Another way to achieve free rent is by negotiating early occupancy at no charge.
Renewal options. Accomplish longer lease terms through renewal options, which provide flexibility and an opportunity to negotiate additional free rent and other concessions throughout your occupancy. Also, make every effort to avoid option rates tied to the so-called “then-prevailing market rate.” Why? Because the term “market rate” is nothing more than the landlord’s asking rental rate and does not reflect the incentives or inducements often required to complete arm’s-length leases (think “sticker price” for cars). As a result, this number will always be higher than the landlord or its agent expects to receive.
Tenant improvements. On new space, tenant improvement (“TI”) allowances can vary widely and generally increase with longer lease terms. On second generation (previously occupied) space, the major costs of improving the space have already been incurred, although new carpet and paint are typical renovations landlords expect to make. Irrespective of the improvements required to make a space suitable for your business, make every effort to have the space be delivered in a turnkey condition… and at no charge to you.
Controllable expenses. Insist that the landlord take reasonable steps to keep operating expenses as low as possible. After all, these costs are generally passed through to the tenants. A 3 percent cap on controllable expenses will help ensure the landlord remains diligent. I suggest that management fees be considered a controllable expense.
Base year. If the lease rate includes the operating expenses of a building (property taxes, casualty insurance, common area maintenance, utilities, janitorial and the like), insist on a base year as far into the future as possible – and never accept the preceding year as the base year.
7 Essential Negotiating Tips
- Plan ahead. Knowing the terms available in competing buildings gives a tenant strong leverage in lease renewal negotiations. Make time your ally by starting the search for space six to 12 months prior to the date it is needed.
- Everything is negotiable. Leasing agents and property managers use terms like “standard” and “typical” when referring to rates and concessions. In commercial real estate, every term and condition is negotiable – nothing is standard.
- Comps are non-existent. Because information about completed leases (“comps”) is generally proprietary, there are no databases available to verify the terms (rental rate, free rent, tenant improvements and the like) negotiated in comparable transactions.
- Not all landlords need to lease space. The greatest concessions will likely come from landlords that have the most urgent needs. Target landlords with a history of granting generous inducements, looking to sell or refinance, or those with high vacancy rates, and make every effort to determine if vacancies are anticipated. Don’t be afraid to ask probing questions.
- Create a paper trail. Submit your proposed terms and conditions in writing. Include a reasonable acceptance date after which the proposal automatically expires and insist on written responses.
- Mum’s the word. Never discuss your budget, circumstances of your business, or other buildings under consideration with the landlord or its property manager and listing agents. As unwitting disclosures will likely create leverage for the landlord and be used against you at the bargaining table, it’s wise to instruct your entire staff to refrain from discussing anything related to your lease or intentions with anyone.
- Rethink doing it yourself. The leasing of commercial space is a time-consuming and complex process, consisting of many interrelated variables. Whether you overpay or are able to negotiate favorable terms depends on your preparation and understanding of the nuances of the entire process. Landlords have advisors to protect their interests, and tenants should, too.
Summary: Every dollar saved in unnecessary operating expenses is a dollar that can be shared with employees, used to purchase equipment, or be distributed to stockholders. Because landlords are the most accommodating before you become a tenant, make certain to recognize and capitalize on every possible leasing concession and anticipate and negotiate protections within the four corners of the lease. Remember, for the fully-informed business owner, healthcare practitioner, facility executive and corporate decision-maker, it’s always a tenant’s market.
Stephen A. Cross, CCIM, owns CROSS Commercial Realty Advisors and is a licensed real estate broker. Mr. Cross advocates exclusively for tenants and buyers and, since 1984, has advised over 2,700 business owners, attorneys, physicians, facility executives, investors and corporate decision-makers on ways to lease and purchase property at the lowest cost and most favorable terms. Contact: 480-998-7998 or firstname.lastname@example.org.