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Property Lease Do-Over
Is Now The Right Time To Strike A Better Deal On Office Rent?
By Phillip M. Perry
Carla, the owner of an Atlanta gift shop, knows only too well what a recession can do to the financial health of a micro-business. Earlier this year a steep sales decline made it tough for her to pay the rent.
We’ve changed Carla’s name because she requested anonymity, but her financial challenge is common everywhere in these tough economic times.
Maybe you can sympathize with the first solution that occurred to Carla: close up shop and walk away from her obligations. But this extreme measure contained a trap. The lease for the 2,900-square-foot store included an acceleration clause that allowed the landlord to collect the full amount of the five-year contract in the event of a missed payment.
Faced with no good alternatives Carla sought advice from a real estate attorney who came up with an unexpected solution. Why not renegotiate the lease? To Carla’s surprise her landlord turned out to be flexible, agreeing to reduce the store rent from $3,500 to $2,000 and even going month to month, which allows either party to cancel the lease on 30 days’ notice.
The story has a happy ending. Carla is now launching new marketing initiatives to spark more sales at her store.
Her story holds an important lesson for micro-business tenants anywhere.
“In the current soft real estate market, the bargaining power is really with the lessee,” says Duncan H. Adams, the attorney who assisted Carla and the managing director of Atlanta-based Adams Law Offices. “The common conception that the landlord is in charge of negotiations is not necessarily true now. In most cities there are a lot of empty spaces, and landlords are looking for tenants and trying to keep the ones they have.”
Tenants Wanted
For the first time in many years tenants are in demand. The reason is no secret—there’s just too much space around compared to the number of active businesses.
“Vacancy rates for all property types began to rise at a gradual pace in the first half of 2008,” says Robert Bach, chief economist at Grubb & Ellis, a commercial real estate services and investment company based in Santa Ana, Calif. “They spiked in the first quarter of 2009 when the credit freeze sent the real estate market into a tailspin. Thanks to the current vacancy rates, tenants are seeing the biggest selection of space and the most accommodating landlords since the early 1990s. Landlords are nervous, so tenants can get better deals.”
By the middle of 2009 the nationwide vacancy for retail space was 9.5 percent, the highest level since the mid-1990s, reports Bach.
For office space the vacancy rate has been running at 15.6 percent—the highest since the first quarter of 2005. About 9.5 percent of industrial space is unoccupied, the highest since the second quarter of 2004.
What do all of these numbers mean for micro-business tenants? You might be able to get a real deal on a property lease, whether you’re at the beginning, middle or end of your lease.
Negotiate Now
As a result of the soft market, tenants are now routinely asking landlords for rent cuts.
“This trend is new,” says Bach. “I have never heard of this happening before at such a wide scale.”
Experts suggest dusting off your lease and taking a fresh look at the numbers even if your renewal date is some time down the road.
“Lessees should be seeking relief right now from their landlords,” says Andy Fried, director of the Small Business Development Center at Kennesaw State University’s Coles College of Business in Kennesaw, Ga. “If the market in a given community is a whole lot lower than what’s being paid on a lease, negotiations should be initiated.”
Rent cuts often take the form of free rent for a negotiated number of months.
“Landlords are often more inclined to grant free months than lower the rental rates,” says Bach. The reason is that a higher official rental rate translates into a higher building value.
The number of free months will vary by market, says Bach. “The tenant must check around to see what deals are being offered.” There’s no harm, he adds, in asking for six months’ worth.
A successful negotiation requires more than just asking, says Sharon Kahan, first vice president at the Chicago-based brokerage of CB Richard Ellis. Prepare documents that show your decline in revenues and the affect on profits.
“Your landlord will ask how your sales are doing, so be prepared to show your figures,” Kahan explains. “Landlords will ask ‘what will you do differently if you get a lower rent?’ Show how you will do a better marketing job with the money you will be saving.”
Win A Better Deal
As you pursue your own lease negotiation keep these eight tips in mind.
1. Favor shorter terms
“Don’t get roped in for a long period of time,” says attorney Adams. “Instead of a five-year lease try to get a two-year lease with the option to renew for successive two-year terms.”
That can save you money if you decide to relocate your business and you’re responsible for the remaining months of a long lease.
2. Be first in line
Make sure your lease includes a first right of refusal clause. This gives you the right to decline a renewal before the landlord offers the space to someone else.
3. Consider a “blend and extend”
If you have two years left on a five-year lease, try getting some immediate rent relief—in terms of free months of rent or a lower monthly rate—in exchange for signing a new five-year lease, provided you feel sure of your ability to fulfill a long-term contract.
4. Find an alternative location
Get a better seat at the negotiating table by having a fallback property space if your landlord balks at a new lease deal. You can say something like this: “We have a brand new deal at a new location for this amount. Or we can do a deal with you at this new number.”
5. Obtain termination powers
Try to get an agreement where either party can terminate the lease with 90 days’ notice, suggests Adams. “Landlords don’t like it, but in this market it’s easier to negotiate exit strategies.”
6. Watch your annual increases
An annual lease increase of 3 percent seems to be the industry standard around the country. But, you should know what the average increase is in your local area.
A landlord might ask for a 4-percent increase in exchange for funding some improvements in your space. Be sure you know what you’re getting for that rental increase.
7. Don’t rely on oral statements
“Do things in writing by certified mail and keep copies of everything,” says attorney Adams. “Do not rely on what someone tells you. If the landlord says ‘Don’t worry about rent this month,’ say ‘I want something in writing for my records.’”
8. Beware of personal guarantees
Try to avoid personally guaranteeing the payments on your lease. A landlord can go after your personal assets if your business fails.
Opportunity Calls
If you find yourself in a financial bind like Carla’s, by all means seek a lease renegotiation with your landlord. A struggling tenant who sincerely wants to pay can look attractive in this market. And no one wants to pursue a lawsuit against a vanished tenant.
“Landlords are falling on hard times, too,” points out Adams. “They have very little to gain by going after a tenant who is unable to pay. Lawsuits are expensive, and collections after a favorable verdict are difficult.”
How urgent is the need to take advantage of all this tenant love?
“I anticipate a further softening of the market through the first half of next year,” says Bach. “Given the expected slow pace of the economic turnaround, good deals are going to be with us for a while.”
New York-based writer Phillip M. Perry is taking a closer look at those lofty Manhattan rents.