When it comes to office leases, a lot has changed over the last few years. Many landlords have added new amenities for tenants to take advantage of, such as gyms, showers, yoga/meditation rooms, secured bike lockers, living room-style lobbies, healthier food, better retail and concierge services. Buildings have been upgraded for energy conservation and environmental sensitivity, along with compatibility with modern technology. We've also seen the re-emergence of serviced offices (also known as coworking space) as an option for start-ups and established enterprises seeking flexibility and hassle-free, soup-to-nuts, full-service occupancy (although usually at a higher cost-per-square foot than leasing your own space).
Along with these demand-driven improvements and with sustained economic growth, the Seattle area has experienced sharp rent increases and a shift in lease negotiation leverage from tenants to landlords.
What hasn’t changed with office leases is landlords’ pursuit of ever-higher cash flow and building valuations.
Smart landlords hire professional building managers who are experts at operating and maintaining buildings and keeping tenants happy. Especially as tenants’ lease expiration dates approach, building managers are keen to keep credit-worthy tenants from having any reason to look elsewhere for their business location. When the time comes to renew the lease, the landlord, through its building manager or representative, will propose renewal lease terms that are likely to shock a tenant who has not tracked the market.
While you and your landlord will both agree on the importance of the quality, safety, security, and image/brand of the building, it’s important to remember that your landlord has an opposing objective when it comes to the cost of rent.
There is a lot of insight the landlord factors into its negotiation strategy, some of which it controls and can accurately estimate and some it doesn't. Landlords have detailed knowledge of the real estate market and, more likely than not, its proposed rent will be on the high side of where the market is trending.
At this point you have some choices:
a) Feel good about the treatment you've received from your landlord over the years and trust you are receiving a close-to-market offer. Make a few phone calls to some of your business associates and maybe to some real estate brokers you know. With that “market research,” negotiate directly, accepting that the market is what it is and you have other things to do than to spend more time on this non-revenue-generating activity.
b) Visit some other buildings you like with “for lease” signs, tour the spaces, talk to the listing agents and get some proposals to use as negotiating fodder with your friendly landlord and try to cut a deal.
c) Or, engage a commercial real estate advisor to broker the deal. In this case, seek a firm that asks the right questions about your requirements and objectives over the projected lease term, and that understands and can explain what the market is doing. A tenant-oriented advisor can explain to you what your landlord is taking into account with its proposal, what the other tenants in your building are doing and when their leases expire, what the impact of your vacancy would have on the landlord’s cash flow, debt and equity capital structure, and value of the building. An advisor will develop a financial model to analyze how renewing or relocating would impact your business and the landlord’s business, accounting for various assumptions and changes in variables such as rent, operating expenses, free rent and fit-out allowances.
Why would you accept a one-sided business proposal from your landlord when you wouldn’t consider doing that in your own business dealings? For landlords there are significant economic differences between a renewal transaction and a new lease. Every nuance of the transaction can have a major impact to the tenant’s financial statements. Landlords or their agents imply there is an ideal solution where landlords and tenants both win. However, this is not the case, because real estate transactions are a zero-sum game. Every dollar by which rent is reduced — or tenant improvement allowance or free rent is increased — is a win for the tenant. Commercial real estate is ripe for negotiation, if you have the right advisor to guide you.
Opting to hire a qualified advisor, who will develop a negotiating strategy and deal directly with the landlord’s representative, confronting contentious issues and advocating for your interests, will results in the best deal for you while maintaining your positive relationship with the landlord. Hiring the right advisor takes time and effort, but if you do it well in advance of your lease expiration date, the outcomes can materially benefit your financial and non-financial obligations over the term of the lease.