A Move Away from Relocation Headaches
When companies face the question of relocating, they have to make a multitude of complicated decisions. Whether the relocation involves 2,500 square feet or 250,000 square feet, evaluating alternative space options remains the same–a complicated, painstaking, and time-consuming process.
Allowing plenty of time is a basic but essential element in the process; users occupying less than 20,000 square feet should allow at least nine months from the space survey until the move-in date; users who need more than 20,000 square feet should plan for a lead time of approximately nine to 18 months or longer.
Part of this time is needed to sort out the many questions and alternatives that present themselves. For example, should a company investigate just a few building alternatives, or should it investigate everything so as not to miss a “good” deal? If the current building is satisfactory, what is the best strategy for negotiating with the current landlord and achieving the best renewal rates as possible? After alternatives are narrowed down to a few, how should they be evaluated so that an apples-to-apples comparison can be made? The factors to evaluate include parking, operating-expense calculations, options (for renewal and expansion), pass-through expenses (the calculations landlords use to charge tenants for common areas, including restrooms, corridors, and lobbies), and tenant-improvement allowances. Furthermore, during recent years the evaluation process has become more complicated due to the large amounts of office space available in most regions and the differences between the quoted rental rate and the lower rates that can be negotiated due to the market’s softness.
Even before facing any of these issues, companies must decide one essential questions before all the others–whether or not to use the services of an office-leasing specialist, or tenant representative. Should company representatives go out on their own and negotiate directly with building owners and owners’ agents? If they choose to hire a specialist, whom do they pick?
Or do they negotiate directly on the most visible projects and hire a broker for the remaining alternatives?–a strategy that usually confuses and complicates the entire process. Worse year, firms sometimes hire multiple brokers while simultaneously delegating the space search to several internal managers–a situation bound to result in conflict and confusion.
Choosing a Stay or Move Sometimes, a company decides that its present building is adequate and chooses not to move. But even this decision warrants careful thought and planning by the tenant. With most U.S. office rental rates decreasing in recent years, what originally seemed to be an attractive renewal rate offered in a contract signed five years ago may not be as attractive in today’s market.
If the present building works and the economics are competitive, usually both the tenant and the landlord gain by retaining the existing tenancy. The tenant representative’s job is to ensure that both sides are well represented in the deal.
Part of being well represented is being well informed. When landlords know that relocation alternatives are abundant and tempting, they are likely to give more concessions. After all, landlords are competitive only when they have to be. For example, on several occasions I suggested that tenants request a proposal form their current landlords. I then met with the landlord and received a second proposal. In every instance the action resulted in tenants saving more than 20-40% on rental packages they otherwise would have agreed to.
In part, the savings came about because I reminded the landlord about the costs that would be incurred if the tenant were to vacate and the space had to be re-leased. These costs include tenant improvements for the new occupant, rental losses during the construction of the improvements, and marketing costs. Landlords almost always prefer to pay a commission to retain a tenant rather than to relet vacant space, and they are not alienated in this process when they see how the benefits are in their favor.
A tenant’s Request for Proposal (RFP) can also be very valuable in the negotiating process. It sets forth the tenant’s “wish list” for rent, terms, conditions, improvements, expansion, and a number of other crucial items. However, the proposal should be properly prepared and presented to get appropriate landlord response. Asking for the moon may terminate negotiations with some developers; sensitivity in this regard is critical to the ultimate success of negotiations.
What About the Broker’s Fee?
It is estimated that more than 75% of Fortune 500 corporations are now using brokerage services. As a result, the issue of eliminating the broker’s commission fee by dealing directly with the building owner is usually not the source of concern it once was. One way to think of it is to compare tenant brokers with travel agents. A traveler can plan his entire itinerary, go to various airline ticket offices, learn the quirks and nuances of the different airlines and their varying policies, coordinate the entire travel package, and still pay the same price as the traveler who uses the services of an experienced travel agent. In both industries, rarely do you get a discount for doing it yourself.
Furthermore, reports occasionally surface of tenants who make direct deals at above-market rents due to their lack of market experience. Also, in many cases the building is represented by an exclusive agent, who shares the fee with the tenant’s broker; the fee is not discounted just because the tenant walks in the door without representation. And, as in the legal system, who wants to be represented by the opposing party’s lawyer?
The Reports Are Useful
Tenant brokers can provide users a number of useful reports: discounted cash-flow analyses of the various alternatives and evaluations of free rent, tenant improvements costs that go beyond standard building allowances, parking charges, base rent increases, operating expense calculations, and options to renew and/or expand. Discounted cash-flow analysis may require analyzing the timing of free rent, the cost differential of tenant improvement allowances, and the cost of money. After all, an above-market rent with the first twelve months rent free is different than a lower contract flat lease.
In recent years, the operating expense base, which some developers use to recapture lease concessions, has also become an increasingly important factor to examine. In fact, imprecise operating-expense bases have been the subject of a number of lawsuits. Landlords who offer future expense estimates that are sometimes unrealistically low give cause for litigation when tenants receive their first-year “increase” bill. For example, if a base operating stop of $6 per square foot per annum is offered, and the first year’s expenses are actually $8 per square foot, the $2-per-square-foot additional rent could negate what a user might have thought was a great deal. However, brokers can minimize this problem by evaluating comparative buildings’ actual operating costs to ensure that the costs of the building selected are in line with reality.
Looking at buildings only from a base-year standpoint still may not provide a true apple-to-apples comparison. Some buildings may have equipment with service contracts that upon expiration can cause increased operating costs, or a building may be up for a property tax re-appraisal that might increase operating pass-throughs. Tenant reps need to keep these factors in mind as well.
Another expense to consider is after-hours HVAC costs. Tenants with small space needs who require HVAC after normal business hours should closely evaluate relocating to an office building offering small HVAC package units or supplementary systems rather than moving to a large office building that needs to operate the building’s entire system to accommodate a partial-floor user. The cost of after-hour usage can vary substantially, ranging from $10 per hour in small buildings to $400 per hour or more in large office complexes.
Tenant reps should also evaluate the load factor. Tenants should know how much the building’s shared spaces are costing them; the difference between an 8% and a 13% load factor can be significant. For example, for a tenant with a five-year lease for 50,000 square feet paying an annual rent of $18 per square foot, the difference between an 8% and a 13% load factor equals $225,000. (50,000 x 18 = 900,000; 900,000 x 5 = 4,500,000; 8% of 4,500,000 = 360,000; 13% of 4,500,000 = 585,000; 585,000 – 360,000 = 225,000).
Tenant reps provide clients another valuable service when they evaluate the reletting potential of their client’s existing space before the tenant signs a new lease elsewhere. The need for this service arises especially when the market is soft, and landlords offer free rent for the existing leasehold term in order to relocate the tenant prior to lease expiration. This can give the tenant an illusion of profit in the expectation of subleasing their existing space. In many parts of the country, subleases of less than three years have been extremely difficult to unload at any price. Unless a tenant rep is able to arrange a sublease, tenants may have to write-off the remainder of the lease term in their lease calculations.
Non-Legal Lease Evaluations
Although office-leasing brokers are not lawyers and should not attempt to carry out legal consultation, they can evaluate the lease document’s function in normal and customary market situations. The need for this evaluation may arise when institutional landlords use the same lease throughout the country without taking into account regional differences. Most of these institutional leases are biased in favor of the landlords, but the most unfavorable clauses will often be deleted if brokers challenge them during negotiations.
A tenant rep may also be helpful in negotiating with a landlord who unthinkingly uses a lease form drawn up many years ago by a family attorney. Even though the new landlord may be a nice person, tenants must live with lease contracts for years; if the building is sold, the document is the tenant’s main recourse to ensure fair play.
In recent years, the presence of asbestos has become a key factor in office building selection, particularly in buildings built before 1976. Tenants must be made aware if asbestos is present in the building and what steps have been taken to mitigate its effects. Knowing the facts before the lease is signed is crucial for tenants who otherwise may be forced to relocate in the middle of the lease term when potential future government ordinances may require total removal of asbestos found within the premises. In addition, how is the issue of who pays for removal or monitoring addressed in the lease contract?
Who’s Got the Time?
Most office decision-makers do not have the luxury of devoting substantial portions of their time to a successful office relocation. This is another way that tenant brokers can help. They can do the majority of information gathering, while decision-makers do just that–make decisions.
For example, if a leasing broker knows that a landlord offered a more attractive incentive package to a prior tenant than what is on the table, this invaluable. Or if the broker suspects that a landlord is having financial difficulties or is always behind on time commitments for tenant build-outs, this information can help clients make much better transactions than if they were unaware.
Furthermore, developers and landlords know that tenants with experienced tenant representation are aware of competing buildings and can switch negotiations if transactions do not proceed smoothly. This alone can save tenants substantial amounts of time and money.
No Easy Road
Office-space leasing is many times more complex than in the past. Office-building alternatives are everywhere, and lease contracts that used to be a few pages long now commonly number 20 or more pages. The bottom-line effects of an improperly negotiated lease contract can have long-term devastating effects on the tenant. Experienced tenant representatives understand the needs and requirements of tenants and landlords, and they are able to serve both parties fully.
Copyright 1990 Commercial Real Estate Investment Institute reprinted with permission from the Commercial Real Estate Investment Journal, Spring 1990, Volume IX, Number 2