Archive for the ‘Transaction Management’ Category
« Older Entries |Where did I put that lease? Finding your best real estate strategy
Wednesday, January 4th, 2012
By Ralph Benzakein, Vice President
Here’s the scenario: You just realized that your lease will be expiring in a few months and you start to think about what that will mean. For the most part, your current space works for you. You might need more open space or a couple of additional offices; the carpet is starting to show some wear; the walls have been marked up a bit. But, it’s close to home and you have a comfort level there (the car practically drives itself to the office). You also remember the nightmare of moving and the disruption to your business.
So…now what? You didn’t get into business to have to worry about this stuff, but now you need to. You decide there is plenty of time to address this and go about doing “more important” things.
At the same time, you begin to notice all of the “Available Space” signs on your way to and from your office. You call one or two of them and discover that although there is a sign in front of the building, there isn’t necessarily any space that would suite your operation, but the broker representing the building would be happy to show you other buildings. It then occurs to you that those signs never really come down and that they are really just a lead generation system for the broker.
More time goes by and brokers are calling you every other day to pitch you new space or tell you how much free rent they can get you. Nobody has taken the time to evaluate what your business needs are and how they can be aligned with your real estate needs.
It all becomes a little overwhelming and with about 30 days left on your lease, you contact you current landlord and “ask” him if you can renew your lease. He says, “Sure, I’ll send you a renewal letter, just sign it and you’ll be good for the next five years.”
Wow, talk about the path of least resistance. You think to yourself, done deal. You read the lease renewal, notice the part about continued escalations (seems reasonable), sign it, and it goes back in the drawer for another four and a half years.
You, my friend, are a landlord’s dream come true!
You may have saved some time, but it came at a very high price. Here are just a few of the items that a tenant rep would have negotiated for you:
- Lower rent (those continued escalations in the renewal have committed you to rent that is well above the market)
- Rent abatement (free rent)
- Refurbishment allowance (new carpets, paint, move partition walls, etc.)
- New base year for real estate taxes
- Reduce or enlarge space, per your needs
- Lower escalations
Your rationale that your landlord would not want a broker involved is accurate. I’ve just shown you why. It’s not because he doesn’t want to pay a broker’s fee, though he probably doesn’t. It’s because many of the countless clauses you are not equipped to negotiate are his profit centers.
And by the way, some landlords are more than willing to pay a broker’s fee, even on the renewal. Some even insist on it to ensure that the broker is not motivated to move the tenant out of their current space.
Bottom line: give yourself plenty of time to determine the best real estate strategy for your business. That usually means at least one year, if not more, depending on the size of your space.
Tags: corporate real estate, cost savings, landlord, lease, tenant
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Tenants Firmly in the Driver’s Seat
Thursday, July 7th, 2011
By Terry Quinn, Principal
As is often the case, there seems to be a public air of optimism, but behind the scenes, most participants acknowledge a continued lack of certainty and visibility related to the overall economy and the commercial real estate markets. This uncertainty is largely driven by the market manipulation of the Fed in terms of QE2 (scheduled to end this summer), negative real interest rates, weak overall recovery, and commodity inflation as a result of the overheated dollar printing press.
Dallas-Fort Worth (DFW) has certainly outpaced most other major markets throughout the country in terms of job creation. As such, it seems that many CRE players are lined up to prepare for the next upward part of the cycle. In the context of the office market, we think it’s a bit early for most landlords and investors to assume that the risks of loss of valuation are in the past. It’s only the sixth inning, and therefore, despite the fact that the Fed has been successful in rebuilding bank balance sheets thereby allowing a delay for many owners facing refinancing, troubled waters potentially remain on the horizon.
The $64 billion dollar question is what happens if interest rates move significantly upward over the next 18-24 months. We recently asked the COO of a major bank here in town about his thoughts regarding the future of interest rates. His response: “The window is between 6 and 18 months, but when the upward movement begins, we think it will move higher and much more swiftly than most expect. The 10 year could easily hit 6% or go higher.”
We recently reviewed the $3.9B of CMBS mortgage loans currently outstanding in the DFW metroplex. 38% of the total CMBS loans in DFW are on the watchlist. This ranks Dallas 3rd behind only San Diego and Riverside/Ontario in terms of the highest percentage of loans on the watchlist. In addition, 84% or $3.3B of the CMBS mortgages mature over the next 60 months.
We also looked at the 4 largest CMBS office loans in DFW scheduled to mature in 2012 (approximately $250MM in aggregate). We then stress tested these loans considering the current net operating income (NOI) and mortgage principal balance. We then applied current underwriting standards and current loan pricing/spreads against a 10 year treasury at 6%. On this basis, only 1 of those properties would have a Debt Coverage Ratio in excess of 1.0 and none would have adequate cash flow to be refinanced without re-capitalization through new equity.
We are not pessimists but realists. Other than a few exceptions, we see the uncertainty and weak economic growth placing tenants firmly in the driver seat. Landlords will continue to aggressively pursue renewals and new tenants to firm up and secure NOI now in order to achieve a refinance or sale before the interest rates move upward to reflect the real inflation pressures in the pipeline.
Tags: corporate real estate, Dallas-Fort Worth, landlord, tenant
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The Incredible Shrinking Office
Wednesday, March 30th, 2011
Technology Hinders Real Estate Recovery But Gives Office Tenants Added Leverage
By Joe Sciolla, Managing Principal
It’s a case of the incredibly shrinking office, and technology is a prime culprit.
Here’s how it works: As technology increases productivity at the workplace, it also leads to a decreasing need for space. Thanks to automation, we need fewer employees, we use less space per employee, and we outsource more jobs overseas. As a result, with new job growth still limited, class A and B office vacancy rates in most markets continue to be high, and rents continue to be flat.
Indeed, technology, while it generally boosts efficiency and cuts costs, also compromises the commercial real estate recovery. This is bad news for landlords. At the same time, however, it’s good news for tenants since they have added leverage as they look to renew their leases or relocate in a “flight to quality.”
Fewer Bodies
With laptops, smart phones, and iPads becoming more sophisticated and more ubiquitous, fewer employees are needed at the office. Today, seven employees can do the work that required ten before the dot-com boom. Moreover, wireless technology has created an environment in which anyone can work practically anywhere at any time.
Today’s virtual office can be a home studio, a car, a plane, or a hotel. While this is clearly not the best set-up for everyone, it has proved to be effective for mobile salespersons, consultants, etc. If a dedicated area in the employee’s home allows for telecommuting, corporations may invest in off-site furniture, phones, faxes, and computers.
Another intriguing arrangement is hotelling, in which companies reserve office space on a “check-in, check-out” basis for employees who are typically on the road. These fully equipped, shared workstations are effective in certain situations, but they may not work when workers are involved with team projects or need face-to-face supervision.
Fewer SF
In the last 10 years, we have seen a significant reduction in the average office space per employee. In 1995, it was approximately 300 SF; in 2000, it was 250 SF to 275 SF; and today, it is about 225 SF or less. A continuing trend is to place more employees in workstations rather than private offices. Today, as much as 70% to 90% of staff members are assigned to workstations, some as small as 36 SF. Almost half of employees today occupy less than 250 SF.
Another trend is the use of collaborative space outside and inside the office. Conference rooms are getting more use, and there’s also greater use of collaborative technology such as videoconferencing, which brings people together at the workplace. Videoconferencing as well as virtual meetings further reduces the need for everyone to work on site. In the office, wireless technology means less hardware, and flat screen computers and TVs consume less space. And while the paperless office is not quite a reality, less paperwork means less space needed to store these supplies.
There’s also the related environmental benefit: fewer trips to the office helps to conserve energy, and less paper helps to conserve trees.
Fewer Jobs
Slow job growth continues to hinder net absorption. Meanwhile, corporate mergers and acquisitions contribute to job losses and excess space. Further exacerbating job growth is the continued flow of jobs to India and other locations overseas.
Reports show that engineers from India perform similar tasks to their counterparts in the States for about one-fourth the salary. In this light, it gives tech companies an efficiency edge when they offshore jobs and operate 24 hours a day.
More Opportunities for Tenants
How can tenants capitalize on these soft market conditions? Clearly, they can use their leverage in many ways as they negotiate with landlords anxious to limit their liability.
First, companies should consider partnering with a corporate real estate advisor that puts their interests first and can save them thousands of dollars. In selecting a real estate service provider, companies should factor in the value of start-to-finish services, including strategic planning and project management.
For companies with fewer than two years remaining on their lease, we recommend they look into early lease renewals. Chances are they will be able to negotiate better terms as well as concessions like free rent and tenant improvement allowances. For companies thinking about relocating, they should, if appropriate, look into trading up into higher quality space.
During contract negotiations, tenants should strive for lease flexibility. This is particularly important for high-tech firms that operate in a volatile market. They should negotiate for expansion as well as contraction and termination options.
Also important during upfront negotiations is space planning and construction management. For example, if a company has downsized, it might consider reconfiguring its space to maximize efficiencies. Here, a project manager can be a huge help.
In the final analysis, technology naturally helps us become more productive. But as technology giveth, it also taketh away. If you’re a landlord, you must deal with our shrinking offices and high vacancies. If you’re a tenant, you should study the market and then crunch some numbers on your laptop. Do your homework—whether at the corporate office or in your home office—and make the numbers work for you.
Tags: corporate real estate, landlord, office space, technology, tenant
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A Glimmer of Hope?: Q&A with Houston Tenant Advisors
Wednesday, March 9th, 2011
Participants:
Sue Rogers, Principal
Steven Heal, Vice President
John Mason, Project Manager
Perry Reese, Senior Associate
Brett Ganz, Senior Associate
Erik Prejean, Senior Associate
What differences are you seeing from the landlords in the deals you are currently working compared to those of the past year?
E.P. - A year ago, I was seeing more free rent offered; now not as much. Fortunately, I am seeing quicker turnaround on commission payments lately.
S.H. – I am actually seeing more free rent being offered and better Tenant Improvement Allowances now as well. However, there isn’t much change in the rental rates.
P.R. – In the industrial industry, I am still seeing free rent being offered. The only difference is that now I am encountering landlords who are “sprinkling” free rent throughout the term rather than all at once at the beginning of the term.
B.G. – Well, it seems to really depend on who you ask and what landlords they are dealing with. Right now, I am not seeing a lot of free rent offered, but I am getting some through negotiations. A year ago, landlords used concessions to entice prospective tenants, but now there is more movement, and landlords are significantly cutting back on what they offer.
S.R. – Landlords, buoyed by the recent activity, will be more aggressive in their efforts to protect face rates, and they will, most likely, decrease free rent and other incentives toward the fourth quarter.
What are your clients expecting right now from you and/or their leases?
E.P. – In particular, I am representing a residential real estate company and an energy company that are pursuing options to provide more flexibility.
S.H. – Tenants that did five-year terms back in 2005 and 2006 are under the misconception that they should be able to find outstanding deals due to the down market and recession, but due to the large rate increases that happened in 2007 and 2008, their renewal rates are typically much higher than their expiring deal.
P.R. – I am actually finding some great deals in the market – however, for the most part, they are all in functionally obsolete buildings. The rate will be great, but the space isn’t user-friendly at all.
J.M. – I am seeing tenants waiting until crunch time to make major decisions about construction. They seem to have the misconception that in the down market, construction companies will jump through hoops for them. In actuality, I am seeing tenants being charged construction premiums, and construction deadlines slipping for lack of manpower.
B.G. – Tenants want to believe they can get a steal, and in certain submarkets, they can. Overall, they are much more difficult to find, though. Last year, it was easier to get class A space at class B rates; this year not as much.
S.R. – As compared to last year, tenants should be even more wary of owners and their ability to fund any capital expenses such as Tenant Improvement Allowances and other economic incentives.
Are there any trends in particular that you are seeing with tenants?
P.R. – I am seeing a lot of tenants attempting to consolidate and sublease space. Budgets are tight, and the outlook is very short term. Tenants are unsure of what is to come with the market and are trying to realistically predict the future.
B.G. – The oil & gas industry and its ancillaries are very strong. I recently picked up two start-up oil & gas companies. Insurance seems to be struggling, and as a result, medical companies are struggling as well due to insecurities about what healthcare reform will bring. Big companies seem to be excelling and focused on future growth, while small companies seem to be drowning in the down market.
So it seems like the market is still in a trough. Is there any glimmer of hope in the near future?
E.P. – Well, the government job growth is still going strong. Here in Houston, consulates are steadily expanding.
S.H. – I am seeing tenants in the oil & gas and energy fields continuing to expand.
P.R. – I think there is a light at the end of the tunnel for tenants due to some active bidding and new contracts, but I believe we still have some time left before we are out in the clear.
J.M. – If tenants are thinking about expanding, now is still a good time. Contractors are eager to work, so it is a very competitive market – a big benefit for the client.
S.R. – The safest move for tenant rep brokers is to work with reliable landlords to avoid an unhappy outcome for your client. Pent-up demand and continued expansion in the oil industry is good news for landlords but could create a shortage of “deals” in preferred submarkets.
How does the Houston market compare to your market? Would you respond differently to any of these questions based on your market’s conditions?
Tags: corporate real estate, free rent, landlord, tenant, tenant improvement allowance
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OPEX: The Hidden Costs, Part II
Friday, February 18th, 2011
By Jason Jones and Kathy Burke, Principals
In Part I, we gave an overview of operating expenses—what they are, what tenants should know about them, and when tenants should be concerned about an operating expense statement from their landlord. In Part II, we will continue the discussion.
The following issues are often predictive of errors and overcharges:
-Substantial capital improvements made within the past year. If improvements have been made to the building during the year, pay very close attention to make sure that the treatment of your operating expenses is recorded according to generally accepted accounting principles (GAAP). For instance, if a new roof is put on the building, or if the lobby was renovated, these types of expenses should be capitalized and, in the case of most leases, excluded from the operating costs charged to tenants.
-Transfer of the property to a new entity. New owners will often implement their own accounting practices and methodologies. In the event of a refinance or sale, it is not uncommon to experience significant clerical mistakes made because the new owner did not properly read your lease.
-Increased vacancy in the building. Vacancy frequently leads to errors and overcharges as a result of the landlord’s process of extrapolating the building’s expenses to reflect what they would have been at full occupancy (commonly referred to as a “gross up”).
What can tenants do to mitigate expenses?
Since you do not control the operation of the building, you need to rely on the professional expertise of the landlord. The items that a tenant can control are typically limited to your HVAC and electric consumption. Keeping thermostats at a reasonable temperature and turning off lights or, better yet, having light sensors installed can help.
Another way to mitigate your expenses is to have a well-negotiated lease document with the right to audit operating expenses. Without this right, you have limited recourse should expenses escalate rapidly.
Many companies perform annual audits as a matter of business practice. This practice alerts everyone that attention is being paid to this issue and increases the level of accuracy. Historically, 80 percent of reconciliation statements contain items that require further clarification, with 25 percent of those statements material enough to warrant an in-depth audit.
What should you ask for from your landlord?
The landlord should be able to provide documentation confirming what was budgeted as well as the actual expenses incurred. This documentation should include a detailed line-item statement with an explanation, by account, of the actual versus budgeted expenses.
It is not unreasonable for the tenant to request at least two prior years’ worth of history, if you have had the same landlord or property manager. This historical data will help you ascertain the validity of the charges, category by category.
Tags: corporate real estate, landlord, lease, opex, tenant
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OPEX: The Hidden Costs, Part I
Wednesday, February 16th, 2011
By Jason Jones and Kathy Burke, Principals
Much like a residential home, commercial office buildings experience normal operating expenses (OPEX) such as taxes, utilities, and ongoing maintenance charges. And, as is the case with a home, the occupant is billed for these expenses on a monthly basis.
Every year, landlords provide tenants with their annual operating expense reconciliation statements. This statement is basically a “true-up” of the actual costs incurred by the landlord versus the costs budgeted and already paid by the tenant. When you receive this document, it would be worthwhile to take a closer look to confirm whether or not the charges are appropriate.
In spite of everyone’s best efforts, there are often mistakes within these documents. Aside from mathematical errors, it’s important to realize most landlords issue their reconciliations based upon the “standard” lease, and your lease may deviate from that standard.
What should tenants know?
A well-negotiated lease document will clearly define allowable operating expenses, detail proper accounting treatment, and specify which costs are not allowed to be charged to the tenant. Typically, “operating costs” include your real estate taxes, cleaning, common area maintenance, building insurance, management fees, and repairs that had to be done during the year.
In practice, your landlord will estimate property expenses for the upcoming calendar year. Tenants pay their percentage share each month throughout the year, based on the budgeted amount. At the end of the year, the actual expenditures are calculated, and during the first quarter of the following year, the landlord will deliver an annual reconciliation statement. Over the course of the lease, these adjusted operating expenses can become a significant expense that should, at the very least, be reviewed and justified. Note that there is enough gray area in calculating operating expenses that entire businesses exist just for the purpose of auditing these costs for tenants.
When should tenants be concerned?
If the expense numbers appear excessive, you should ask your landlord for an explanation, subsequently following up with your real estate adviser to confirm whether or not they are consistent with the market.
Often, the best way to ensure accuracy is to request that your real estate advisor perform a “desk-top” audit. The first indicator of a billing error is an excessive percentage increase from your last year’s operating expense statement. Note that with the exception of taxes, insurance, utilities, repairs, and maintenance (based on the age of your building), it is customary for most categories of operating expenses to escalate less than 5 percent per year. Anything beyond this number requires further clarification. If you reach a double-digit number, an explanation is due.
Stay tuned for Part II, where we will discuss issues to look out for, what tenants can do to mitigate expenses, and what tenants should ask their landlord for.
Tags: corporate real estate, landlord, lease, opex, tenant
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Navigating the Transaction Process – Part II
Wednesday, January 26th, 2011
Supporting the Strategy: The Bones of the Deal
By Liz Roberts, Vice President
In my last blog entry, Navigating the Transaction Process – Part I, I discussed the general definition of Transaction Management, as well as the first step in the Transaction Process—Define Requirements.
The second step of the Transaction Process—Decision Support—involves gathering the analytical and market data necessary to enable and support the strategic initiative and to narrow down the many real estate options in the marketplace, or the “bones” in the body of your transaction. Decision Support is made up of both internal corporate processes and external market processes, which integrate to create the structure for decision making.
Internal processes will vary from company to company. It can be as simple as one decision maker engaging the broker and the marketplace, to a corporate real estate department presenting recommended real estate decisions to the C-Suite or Board of Directors.
Especially for single-office transactions, once you’ve identified your internal process, you can begin the external process, which includes:
1) Site Tours & Inspections. Who doesn’t like to look at real estate? We all know in real estate it’s “Location, Location, Location,” and during the site tours, the obvious factors will have an impact on the stakeholders’ decision process:
-Building quality and image
-Lobby exposure
-Parking
-Onsite and offsite amenities
-Ease of access
However, less obvious factors may more likely define whether a location is a viable candidate; these include:
-Stability and liquidity of building ownership
-Existing tenants
-Schedule of delivery
-Condition of base building components
-ADA and environmental requirements
-Building infrastructure
-After-hours operational costs for HVAC
2) Demographic Analysis. Does the labor pool match your employment profile? Is the location convenient to your current employees? This step often includes a labor study and ZIP code or similar analysis to map specific buildings against current employee home addresses. This can be a very important piece, as historically, most employees will strongly resist a relocation that extends their commute by 20 minutes or more.
3) Municipal Analysis/Incentives Research. Do you qualify for government grants or tax credits? If this project creates new jobs, for example, you may qualify for training grants. Each state offers a multitude of possible grants, tax credits, or low-interest financing. Working with your real estate consultant to contact economic development agencies could turn into significant savings and greatly impact your real estate Decision Support.
4) Request for Proposals (RFPs). This is just what it sounds like, a request for information to landlords of buildings that have made a short list. In the RFP response, the landlord describes how the property can accommodate your time frames and physical and financial requirements. Especially in our current economy, the RFP should include a detailed request to examine the landlord’s financial stability.
5) Short List of Alternatives. At this point you’ve collected quite a bit of information to support your Defined Requirements and should be able to narrow down your options to the top two or three alternatives.
6) Space Planning. Time to get creative! Once you have your top alternatives, you need to ensure that the Space Program you developed during the Define Requirements step works in the spaces that you are considering. Does everything fit into the space? Has the planning accounted for an easy integration into additional or less space? Is one alternative more efficient than another?
7) Preliminary Budget & Schedule. So what is all of this going to cost? Aside from the rent and operating expenses that you will incur with any lease, there is also the cost to build out the space along with likely one-time capital and expense costs such as IT, FF&E (furniture, fixtures, and equipment), restoration, and relocating your team.
8) Negotiation Plan & Optimum Deal Structure. With this information, you and your real estate advisor can look at your initial criteria and determine how to best approach the negotiation in order to move forward with the deal structure that best suits your needs. Regardless of what this deal structure is, you now have what you need to enter into your Analysis and Negotiation, which I will delve into in the next blog entry.
Tags: corporate real estate, tenant, transaction
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Conflicts of Interest: Tenants Should Question Dual Representation
Wednesday, January 12th, 2011
By Craig Zodikoff, Managing Principal
The economy may be improving, but companies are still trying to cut costs and maximize value with all of their outsourced services. Since real estate is often the second greatest corporate expense following payroll, there is added incentive for companies to evaluate their commercial real estate service provider.
These dynamics are causing more corporate space users to reassess their real estate plans, including the consideration of firms that specialize in tenant representation in addition to traditional firms that represent tenants as well as landlords.
Another consideration is fueling discussions about service providers: Corporate America today is more vigilant as a result of the Sarbanes-Oxley legislation and ensuing business reforms and regulation. CFOs continue to have more oversight for real estate decisions and are ever-mindful of sweetheart deals and murky relationships. In fact, senior management is now more sensitive to even the perception of conflicts.
Protecting Your Interests
A conflict of interest may result if brokers represent landlords and tenants in the same market. When this happens, brokers may lose their objectivity, and the interests of tenants may be compromised.
To use a legal analogy, it’s common sense for plaintiffs and defendants to have separate representation in the courtroom. Should it be different for tenants and landlords in the boardroom, where high-stake real estate decisions are made?
This question has caused companies to challenge business as usual. The Watkins Research Group surveyed corporate real estate executives (CREs) to determine preferred business models. It found that 70% of CREs surveyed cited “no conflict of interest” as a significant criterion in selecting a real estate service provider.
Sometimes, tenants question why conflict would be a problem if their broker doesn’t represent their landlord. The issue is that firms whose primary source of revenue is landlord representation have a vested interest in preserving the strength of that client base. They also have a vested interest in avoiding the devaluation of a building—or the market as a whole—since their other clients would not like to hear that lower market comps are tied to their broker’s deal.
Considering the Bottom Line
The largest real estate brokerage houses derive about three-quarters of their revenue from owners and investors and only one-quarter from space occupiers. Tenant firms can more objectively push the landlord for better terms and not worry about future agendas.
This conflict can be very costly for occupiers seeking the best terms and conditions. Today, the stakes are even higher with fewer tenant advocates available (following the merger of The Staubach Group and Jones Lang LaSalle) and more potential for conflicts.
Challenging the Old School
Why haven’t tenant representation firms gained a greater foothold in the marketplace? Landlord clients tend to provide greater revenue to listing brokers than tenants do. Not surprisingly, they are motivated to enhance their future listing opportunities with landlords.
In addition to handling transactions, tenant advisory firms focus more on start-to-finish corporate services like Strategic Planning and Project Management. These offerings are typically lower on the priority lists of traditional brokers because they aren’t as lucrative as transaction-based services, but they are critical to the success of the project for the tenant.
Another deterrent to would-be tenant-only firms is tied to marketing considerations. Brokers who represent landlords receive valuable visibility when they post their signs on their clients’ buildings to advertise the space. Tenant representatives typically don’t enjoy this free advertising and brand name awareness.
Advocating for Tenant Rights
As the market grows more sophisticated, more corporations are questioning their existing relationships, and many tenants are discovering that their interests are best served when they have their own advocates.
We recommend that tenants raise the issue of conflict from the get-go, starting with the selection of their real estate provider. We advise clients to exercise their rights and ask for full disclosure from brokers. Ultimately, to ensure the fairest and best representation possible, tenants need to understand the interest of their representative to be sure their best interest is the top priority.
Tags: conflict of interest, corporate real estate, landlord, tenant
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Creative Tenant Solutions: The Blend and Extend
Wednesday, January 5th, 2011
By Darren Fleming, Managing Principal
As vacancies rise and rents begin to fall, some companies may grow frustrated about being unable to take advantage of a newly favorable market. So I thought I’d discuss a strategy that might be of interest: the blend-and-extend.
A blend-and-extend is when a tenant, typically with a few years of remaining lease term, signs an early renewal agreement with the existing landlord to add a few more years to their current lease. Usually this is done for one of two reasons: 1) to achieve a lower rental rate today or 2) to secure financing from the landlord to offset future construction costs. In both cases, the rental rate on the additional term is blended into the existing rate to create a new ‘blended rate’ that is often lower than the original one.
The mechanics of a blend-and-extend are relatively simple to understand. Let’s imagine a 15,000 SF company that has two and a half years left on its office lease and is paying $30/SF in a market where the rental rate for a new lease has dropped to $25/SF. Using simple math, if that tenant extended its lease for an additional two and a half years at $25 then the new average, or blended, rental rate would be $27.50. This would represent an immediate reduction of close to $100,000 spread over the original two and a half years.
Executing a blend-and-extend, however, can be very challenging and depends heavily on timing and reading the market. How do you know market conditions are right? How do you convince a landlord to go along? When is the right time to bring it up? It all depends on the situation.
The best part is if you aren’t able to negotiate enough of a savings, you already have several years of lease term remaining and have lost nothing but time.
In the context of a falling market, tenants can look at things from the landlord’s perspective and identify a positive rationale for the owner to go along with. Perhaps having your firm extend by a few years will eliminate some upcoming risk in their portfolio due to the chance that you might leave. If they aren’t open to this type of idea, in a few years they may have to compete for your tenancy on the open market and have a better chance of losing you to a competing building. Showing them how to eliminate that risk could be very appealing.
If your firm is planning major renovations or a purchase of expensive equipment that’s cost prohibitive or even impossible to move, then a blend-and-extend might be a good solution. Spending major, non-recoverable dollars in someone else’s building is a clear sign that you aren’t likely (or able) to move at the end of a lease. Thus, a savvy tenant should take preventative measures to avoid the appearance of captivity. Otherwise, they may find themselves without any real leverage come time to renegotiate the rent.
A successful blend-and-extend requires a lot of work and a high degree of market intelligence. Tenants must have a good idea of their landlord’s current bottom line, or they are setting themselves up for a failure before they even begin. Do your homework. Talk to other tenants in the building or in the business park to get a sense of where the market is heading. Are there any big leases expiring close to your own in your landlord’s portfolio? Will they be eager to lock down your tenancy, or will they be happier to wait a few years in hopes that the market recovers? This is information you must have because, rest assured, your landlord is a local market expert and certainly takes the time to stay informed; it’s their job.
Tags: blend and extend, corporate real estate, cost savings, landlord, tenant
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Forewarned is Forearmed: Read Your Lease
Wednesday, November 17th, 2010
By Darren Fleming
It may seem like simple advice, but reading their lease is something that a disturbing amount of tenants just do not take the time to do prior to signing, or resigning, their office lease. In fact many of our clients are not the same person who handled the last transaction on behalf of their organization. As a result, they do not possess any of the historical context that was at play five or ten years ago when the current contract was signed.
That’s why it is so important that before any action is taken that you read the lease – thoroughly. This means cover-to-cover, all the schedules, and any amendments that might have been made. Take notes and call an expert you trust if you have questions. There are potentially many hidden costs in a commercial lease and several of them come into play only at the end of the contract. So before you decide to talk to your landlord you had better be up to speed on your rights and obligations in order to avoid any nasty surprises. In this entry I will discuss two of the more common lease clauses I have seen that can cause problems and offer some tips and strategies to deal with them.
Protect your option to renew
The majority of tenants do not understand the purpose of an option to renew, or why it is a must-have in any lease. These clauses, which usually carry a requirement to give the landlord six or nine months’ advance written notice if they are to be exercised, are not just there to provide a reminder to talk to the landlord. Their sole purpose is to prevent a landlord from leasing your space out from under you in the event a more attractive tenant comes their way.
You may have spent major dollars retrofitting your 5,000 SF office when you moved in five years ago, only to have the property’s anchor tenant negotiate to take your beautiful space should you forget to exercise your option to renew. That is why it is essential to be aware of your notice obligations at all times. If you miss your notice window you have likely lost the option forever.
Restoration/reinstatement obligations
Unbeknownst to most tenants is that at the end of the lease term most standard commercial leases require a departing tenant to return a space back to its base building condition. This usually means bare concrete floors and the demolition of all interior walls. In most cases the landlord also has the right to insist on doing the work on the departing tenant’s behalf and all at the tenant’s expense. What’s worse is that many leases state that even if you were not the one who did the construction in the first place, you can still be on the hook for the removal. This particularly nasty surprise can be hard to spot and if you suspect you might have this type of clause in your lease, call an expert for advice on how to handle it.
Many uninformed tenants have had their negotiating leverage eliminated in one stroke when informed by their existing landlord that they would be charged thousands of dollars should they fail to renew their lease and leave. In some cases a tenant may then find themselves in the position of being unable to move and they typically renew at a higher rental rate than they might otherwise have been able to negotiate. The best defense is of course to strike this clause from the document before you sign but since time travel isn’t an option, when faced with a potential restoration obligation, you will likely have to get creative to avoid writing a big check.
It is vital to ensure you are aware of any potential pitfalls in your lease that could affect your company at the end of the term. Failure to do your homework and take preventative steps will undoubtedly cost you money. Forewarned is forearmed.
Tags: corporate real estate, landlord, lease
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