Tenants and lessees often consider lease renewals to be perfunctory and routine. They may not be aware how the renewal process can give landlords the upper hand in setting terms of this new contract.
In fact, as soon as lessee signs the original contract, future negotiating leverage shifts to the landlord. Landlords knows that unless the lessee outgrows the space or has another strong reason to relocate at the end of that lease, they’ll gravitate toward re-signing and staying in that leased space. Landlords understand that businesses owners value continuity, and relocating is costly, disruptive to their business, and distracting for their employees.
That’s why a lessee, through their CRE representative, should employ the same strategy for renewals that they did when they negotiated the original lease. These negotiating fundamentals include:
- Beginning early.
- Knowing the market.
- Keeping your cards close.
- Watching the fine print.
The first three elements increase a lessee’s negotiating leverage. The fourth helps ensure certain lease provisions are in place or removed to minimize costs and risks for the lessee’s business.
Depending on the company and the industry, relocating a business can take anywhere from ten to 12 months, encompassing time for negotiating, building out the space, re-cabling, packing, unpacking, location branding, and more.
That’s why, in today’s market, having 10 months or less remaining on a lease means the renewal negotiation advantage shifts even further into the landlord’s favor. Landlords know there’s a less realistic chance the business can relocate if they dislike the new, proposed renewal contract terms. The lessee’s CRE representative should begin lease negotiation discussions well before that 10-month “go/no-go” point in time.
Know the Market
At or around 15 months prior to the lease expiration, the lessee’s CRE tenant representative should research and explore commercial space alternatives available in the next four to eight months. They should uncover location options just as if their client was planning to relocate. This market intelligence should be used to:
- Determine market-based sq. ft. rental rates and other lease economic factors (e.g., tenant improvements allowances, rental abatement concessions, and relocation allowances) to guide the renewal negotiation.
- Identify legitimate relocation options for the lessee that the CRE representative can share with the landlord or landlord’s agent to enhance negotiating leverage in the lessee’s favor as they discuss the lease renewal and further negotiate renewal contract terms.
Keep Your Cards Close
A good landlord will stay in close touch with their tenants. But that outreach may be more than simply a demonstration of good customer service. The landlord is also likely trying to gauge the lessee’s long-term intentions and how entrenched they are in the space.
In these conversations, a lessee should never volunteer anything along the lines of: “We don’t see the need to ever leave this spot” or “This space will suit us for years to come.” A more strategic comment would be something like: “The space meets our needs at this time, but we’ll evaluate our options in the marketplace as the time to consider a renewal of the lease approaches.”
Watch the Fine Print
In addition to helping a lessee maximize their renewal negotiation leverage, a CRE representative can identify lease provisions that should be added, changed, or adjusted in a proposed renewal lease agreement. For example:
- Revise the base year. During the first (or base) year of a full-service lease, a landlord assigns the lessee a portion of the building’s operating expenses based on their pro-rata share of the building. This amount is included in the rent payment and adjusted annually. Over time, as building operating costs increase, the “pass-through” expenses can become quite significant. Re-setting the base year at the time of a lease renewal is a critical deal point that limits additional out-of-pockets costs going forward.
- Extinguish personal guarantees. Often a new business owner is required to guarantee their first lease financially and personally. But several years later at renewal time, the business is usually well-established, and the original tenant improvement allowance has been fully amortized, so in most cases personal guarantee clauses shouldn’t be required and should be removed at the time of lease renewal.
- Maintain renewal options. Landlords will try to retain the contractual flexibility to move a lessee in order to accommodate a new tenant or another current tenant that requires more space. Similarly, many lessees want to maintain expansion or contraction flexibility in their own contracts. In a blog last year, we discussed these issues (including the landlord’s Right of Relocation and the lessee’s expansion and continuation options), along with the contractual provisions that protect a lessee’s rights in both situations. The lessee’s CRE representative should take the opportunity during the renewal to review these provisions and make sure the terms still reflect the lessee’s future interests.
CRE lease renewals are anything but routine. There are obvious as well as less obvious opportunities for both the lessee and the landlord to improve the terms in their favor. Renewal negotiations can and should be as complex as they were for the initial lease.
Please give us a call at least 15 months before your next lease renewal and we’ll put these strategies to work and these protections in place for you.