Overcome the Security Deposit Deadlock

It’s not uncommon to arrive at an impasse when negotiating the security deposit for a commercial office lease, since it can often be the final business point to negotiate during the proposal process following the landlord’s review of the tenant’s financials.  So what do you do when the landlord proposes a security deposit that’s substantially higher than your expectations or capabilities? 

It’s first important to understand how the landlord arrives at their determination.  To say building owners are somewhat risk adverse is like saying fish prefer to swim in water.  Different factors motivate different ownerships, but generally they’re looking for a security instrument that will cover at least a portion of the following in the event of a default:

• Transaction expenses such as brokerage commissions and legal expenses
• Tenant Improvement Allowance / Construction & design costs
• Vacancy loss (as landlord relets premises)

How big that portion is will depend on the tenant’s credit: several factors include the length of the tenant’s operating history, existing debt obligations, burn rate (if investor-backed), profitability and current cash position.  

Here are a few solutions you can propose to overcome a deadlock when there’s disagreement in the security deposit: 

• Burn Down:  Propose a structure whereby the cash security deposit burns down over time, either in the form of a rental credit or a return of the cash.  Example: the security deposit amount burns down by one month for every year the tenant makes timely rental payments. 

• Irrevocable Letter of Credit (LOC):  In lieu of a cash security deposit, a landlord may agree to the tenant securing the lease with an LOC.  The main advantage to this is that the cash stays on your balance sheet and is thus deployable for salaries and operating expenses.  In the event of a default, the landlord may draw upon the LOC at which point it becomes a liability; however, until then it’s simply an off balance sheet disclosure. 

• Cash Security Deposit / Pre-paid rent:  This is a hybrid of the Burn Down.  Example: give the landlord a one month cash security deposit and prepay 6 months’ rent in advance. 

• Good Guy Clause (GGC):  This is a great solution for start-ups with limited cash and a short operating history, and landlords who are worried about a costly eviction process if the tenant defaults.  Basically, an individual signs a personal guarantee with the landlord that’s terminated as long as the tenant agrees to vacate the premises and leave it in good condition if they can no longer afford to pay rent.  Read more about the GGC here. 

Even with the above solutions, a landlord and tenant are still too far apart on terms.  Revisit the path your landlord took in determining the dollar amount, and consider ways to reduce their economic exposure.  Perhaps you could take the premises “as is” and defer tenant improvements until later, or your broker could agree to defer their commission until a later date (personally, I do this for startups often).  

Finally, you may simply need to consider a different property with a different ownership structure that is less risk-adverse, or perhaps a co-working space until your company matures (read “Co-working: the good, the bad and the kombucha keg”). 

In closing, it’s important to agree to the security deposit early on in the process so you do not waste time if you ultimately arrive at an impasse.  

How the Sale of Your Building Could Cost You Money

California’s Proposition 13 provides a statutory limit on annual increases to the assessed value of a property. Basically, the state general levy tax rate is limited to 1.0% of the property’s value and cannot increase more than 2.0% per year, unless the building is sold, more than 50% is transferred, or substantial new construction is completed.  (Note that the tax rate can and usually does exceed 1% because there is no limitation on municipal tax rates or special assessments).

So what does this mean to California’s office tenants?  If the building you occupy sells to a new owner during your tenancy, the building could be reassessed at a much higher value than when you initially moved in, and you could get stuck with a substantial increased tax bill passthrough.

Let’s assume that your company leases 10,000 square feet in a 100,000 square foot building (10% pro rata share)  and signs a 5-year lease in 2013.  Let’s also assume that the building hasn’t been sold in a while, and therefore has a low property tax assessment.  For our example, we’ll pretend that the building is currently valued at $200 per square foot, or, $20,000,000, and that in 2013 property taxes for the building were approximately $300,000 (at a rate of 1.5%).

Increases in operating expenses such as property taxes are passed through to tenants and collected according to the tenants’ pro rata share.  Therefore, when taxes are increased by 2.0% to $306,000 in 2014, you will have to pay your 10% share of the $6,000 increase, or $600.

However, let’s say that in 2014 the owner of your building decides to sell it to an investor for $50,000,000 ($500/SF), the property is reassessed and taxed on the new value, and the property taxes are increased to $750,000.  In this example, the increase in property taxes from 2013 to 2014 would be $444,000 and since your firm occupies 10% of the building, you’d get handed a bill for $44,000.  And the fun part? You’ll get to pay that bill every year until your term runs out.

So is there any way to avoid this?  Yes, but it’s highly unlikely.  If you’re a large tenant in a soft market, you may be successful in negotiating “Prop 13 Protection” into your lease, whereby any “Due On Sale” taxes cannot be passed through to you.  Building owners are extremely resistant to agreeing to this, however, as it adversely affects the selling price.  Another strategy, if you know a sale is imminent, is to try and get your Base Year set to the year of the anticipated sale which could be achieved in a new lease or upon a renewal.

For everyone else, it is crucial that you do your homework before signing a new lease or renewing your existing one.  Being well informed is the name of the game.  Assuming you do business in a market that continues to appreciate, the more time that has passed since a property’s last reassessment, the larger the increase will be upon a sale.  I call it “The Rubber Band Effect” – the more you stretch it, the more it’s going to hurt when it snaps.

Knowing not only when the subject property was last reassessed but also the likelihood the ownership could change hands during your tenancy should be a top priority and can help you avoid egregious and unexpected pass through expenses that most all office tenants are exposed to.

Tech Tenants: Build It, and They Will Come

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By: Carson Hopkins

CompStak talked to brokers and tenants about one of the fastest growing tenant industries in commercial real estate.

It’s no secret that the startup industry is booming. From major hubs such as San Francisco and New York to smaller cities like New Orleans and Providence, more and more internet-based companies are cropping up each year.

With this growth comes an expansion of startup culture. Marked by their laidback workspaces and innovative approach to office dynamics, these companies are transforming work environments across the country. Landlords and brokers are keeping tabs.

“It’s not just what tenants want that has changed,” said Benjamin Osgood, Senior VP of Tenant Representation Services at Dunhill Partners West in San Francisco. “It’s also work culture that has changed – it’s more fun. What it means to go into work is different nowadays. There’s more flavor, more style.” A few decades ago, offices looked identical from one corner of a city to the other. Today, companies’ personalities are coming out in their workspaces.

With high rents and high competition in major cities, the search for office space has grown increasingly difficult for these tenants. Yet the demand shows no signs of slowing down, in part because the right work environment is crucial in recruiting top talent. “There’s a tremendous amount of competition in tech,” Osgood said. “The space plays a big role in luring employees – all things being equal, that competitive edge that companies can offer is their space. Engineers talk; they know who has free lunch or the room dedicated to Corn Hole.”

Coleman Skeeter, founder and CEO of New York CRE advisory firm Truman James agrees that Tech comprises one of today’s hottest real estate niches. “Technology tenants are arguably the biggest driving force in the current climate of record-high rents and record-low vacancies” in New York City.

When searching for office space, tech startups often face challenges that long established companies in other fields avoid. Namely, they lack established, good standing credit. “Some owners are skeptical of startups,” said Kalin Kelly, Director at CM Commercial Real Estate in San Francisco. “They could do really great or they could walk away from the lease and have to terminate.” Skeeter adds that some landlords are wary of taking on tech tenants out of fear of another dot-com bust. “No matter how much forecasting you do, you can never know exactly how fast your company might grow, “which is why we prefer to work with landlords that are more friendly and flexible for our clients.”

Flexibility is certainly a strong preference among tech tenants, especially those in the high-growth phase. The more mature tenants have different needs – they are looking for a permanent headquarters – a place that Skeeter says “reflects the core ethos of their firm, while serving as a creative space for their staff.”

However, most tech tenants are far from that stage. “They need spaces that they can modify and/or grow into,” says Matt Currie, a Principal Broker at CM Commercial. “Most enticing are options that will help them a year or two later, pending growth of the operation.”

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Indeed’s office at the Champions development in Austin, TX

Derek Stewart, head of real estate at Indeed, a technology company that operates the world’s largest job listings website, said he and his team were initially wary of leases with long-term commitment because their company has grown at such an aggressive rate. In fact, Indeed has never been in one office for longer than two years, as they often outgrew the space. Stewart advises high growth tech companies to do one of two things: “Take super short term lease and make it work for your current needs, or take far more space than you’ll ever need just so you don’t have to move in a couple years.” He said growing out of an office and having to sublease it can be detrimental, since before long companies may be bogged down with two or three leases they’re still paying for.

In addition to lease term flexibility, there are many other factors that technology tenants consider. “Location, location, location. It’s a cliché, but it’s true,” said Osgood. “Proximity to good restaurants, bars, and coffee shops is a strong incentive.” Kelly added that aesthetics and easy access to public transit are also important to her San Francisco clients, while Currie adds: “overall vibe and energy” matter.

The cool factor that tech companies are searching for extends beyond the office’s neighboring establishments to the interior layout of the building. High ceilings, open floor plans, wood floors, exposed brick and HVAC, glass, and stained concrete are all in high demand. Osgood, however, said he sees a trend in scaling back the amount of open space. While open floor plans remain a favorite of tech companies, “There’s still a need for private space,” he explained. Companies are realizing that the demand for more meeting rooms and even server rooms is still there. “Being totally open doesn’t work,” Osgood said.

The balance between open and private is well-reflected in the choice that NYC-based startup Floored has made. David Eisenberg, founder and CEO of Floored, said he and his team hoped for a space of “collaboration yet peace.” They searched for a space that offered both an open floor plan with high ceilings, and glass-walled conference rooms. The lease term was also critical, as it’s “hard to predict more than a year or two in advance,” he said.

In spite of their success in finding a new space, Eisenberg still lamented, “how old school the search process is.” He credits his broker for speeding up the search so he and his coworkers didn’t have to spend the time and energy searching through “black and white 2D floor plans that may or may not be up-to-date.” Working with a broker who pre-walked floors and only showed them well-suited spaces made for a more efficient search. (Floored is actually assisting the CRE industry in this regard, with its 3D tour technology.)

Derek Stewart concurs that the space layout was also of paramount importance for Indeed. As the company is set to continue its tremendous growth in the months and years to come, they’re keeping in mind ways to interest those future employees. A great space is necessary in order to attract the number of people Indeed needs to bring onboard, Derek said. He added that while some startups may prefer playful workspaces, Indeed was hoping to find a balance, looking to create an environment that is modern and creative but also practical and mature.

There’s no denying the impact that tech tenants have had on the commercial real estate industry. As tech startups continue to grow and expand into new markets and cities, landlords and leasing brokers may want to pay more attention. In recent years, “velocity of transactions has accelerated, length of transactions has shortened, and volume has increased,” said Currie. The tech industry is growing, and despite the high turnover rate and associated risks, more landlords are catering to tech tenants. They’re “very accommodating because they want the highest rent possible,” said Kelly. “They’re willing to make spaces cool and creative by exposing concrete, putting in wooden floors, and adding other in-demand amenities.”

Skeeter adds, “landlords who want to attract the best companies, need to think like residential landlords and offer amenity packages.” Bike lockers, showers, gyms, common eating spaces, standing desks, soft seating areas, and Wi-Fi lounges have proven especially popular with tech companies.

“Build it,” Skeeter says, “and they will come.”


CompStak Exchange is a free platform for CRE brokers, appraisers and researchers to exchange verified commercial lease comps anonymously. CompStak Enterprise offers unlimited fee-based access to comp information to CRE landlords, lenders and investors.

Help a Vet by Donating your Suit to the “Interview Attire Workshop”

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Dear friends,

Please join me in supporting St. Anthony’s efforts to help veterans re-enter the workforce by donating your new or gently used suits, sport coats, slacks, shirts, ties, belts and shoes.

I’m sure we all have some great clothes collecting dust in our closets, so here is a GREAT opportunity to put them to good use, while giving a little back to a community that really needs our help.

Donations can be made directly to St. Anthony’s however if the financial district is more convenient for you, we’ll be accepting donations here at Dunhill Partners West until October 29th (please just call in advance so we know to expect you).

Financial District Drop-Off:
Dunhill Partners West
388 Market St., Suite 850
San Francisco, CA 94111
Contact: Benjamin Osgood (415) 298-3331

Tenderloin Drop-Off:
St. Anthony Foundation
150 Golden Gate Ave.
San Francisco, CA 94102

• What: Honoring the service of homeless and low-income Veterans
• When: Friday, November 8th 10:00am – 12:00pm

• Where: St. Anthony Foundation 150 Golden Gate Ave. San Francisco

This year St. Anthony’s is offering veterans who are ready to re-enter the workforce a workshop to help them prepare for interviewing and work.  They have and continue to collect new and gently used suits, sport coats, slacks, shirts, ties, belts and shoes. Each veteran (they expect about 50) will have an individual appointment and a personal consultant to assist them in putting their best foot forward. Personal consultants will be volunteers with knowledge of menswear attire and image.

They are partnering with the San Francisco Department of Veteran Affairs and the San Francisco VA Clinic. Planet Sox and Craigslist Foundation are corporate supporters.

Twenty percent of the guests who eat at St. Anthony’s Dining Room are veterans and they serve up to 3,000 free meals per day.

Your donations mean a new start for a veteran struggling to regain an economic foothold in our community and looking sharp is a confidence-builder when facing a challenging job market.

Thank you for taking the time to read this, and please feel free to pass along if appropriate.

Warm Regards,
Benjamin Osgood

CLICK HERE FOR DONATION ACKNOWLEDGEMENT FORM

PHOTOS: Transbay Transit Center Hardhat Construction Tour

To call the new $4 billion Transbay Transit Center development anything less than spectacular would be a gross understatement. The sheer magnitude and scale of the project is staggering and the cutting edge building and engineering processes being implemented will make your head spin.

The Transbay Joint Powers Authority (TJPA) which oversees the project, generously offered to give the USGBC’s Northern California Chapter a behind the scenes construction tour, which followed an extremely informative powerpoint presentation.  Due to overwhelming demand, the tour was available only to current members of the USGBC’s Northern California Chapter and registration for the free event closed in less than one day. (Click here for information about joining our chapter.)

Sustainable design and construction is at the center of the project and comes with its own set of challenges due to the size of the development. As Brian Meinrath from environmental design consultant Atelier Ten explained, some laws didn’t even exist to allow some of the things they wanted to do, such as recapturing graywater from sinks to flush toilets. They worked with local government to create standards and permit its use.

The project is truly an engineering marvel requiring unprecedented levels of communication and cooperation amongst firms and agencies.

The project team is clearly world-class and the USGBC’s Northern California Chapter couldn’t be more thankful for their time and expertise. Thanks again!

TJPA: Maria Ayerdi-Kaplan
Transbay PMPC team: Joyce Oishi
Turner Construction: Jack Adams
Atelier Ten: Brian Meinrath
WSP: Wayne Gaw
Integrated Environmental Solutions: Mark Knipfer

How the Sale of Your Building Could Cost You Money

Jarvis
Howard Jarvis – Author of Prop 13

California’s Proposition 13 provides a statutory limit on annual increases to the assessed value of a property. Basically, the state general levy tax rate is limited to 1.0% of the property’s value and cannot increase more than 2.0% per year, unless the building is sold, more than 50% is transferred, or substantial new construction is completed.  (Note that the tax rate can and usually does exceed 1% because there is no limitation on municipal tax rates or special assessments).

So what does this mean to California’s office tenants?  If the building you occupy sells to a new owner during your tenancy, the building could be reassessed at a much higher value than when you initially moved in, and you could get stuck with a substantial increased tax bill passthrough.

Let’s assume that your company leases 10,000 square feet in a 100,000 square foot building (10% pro rata share)  and signs a 5-year lease in 2013.  Let’s also assume that the building hasn’t been sold in a while, and therefore has a low property tax assessment.  For our example, we’ll pretend that the building is currently valued at $200 per square foot, or, $20,000,000, and that in 2013 property taxes for the building were approximately $300,000 (at a rate of 1.5%).

Increases in operating expenses such as property taxes are passed through to tenants and collected according to the tenants’ pro rata share.  Therefore, when taxes are increased by 2.0% to $306,000 in 2014, you will have to pay your 10% share of the $6,000 increase, or $600.

However, let’s say that in 2014 the owner of your building decides to sell it to an investor for $50,000,000 ($500/SF), the property is reassessed and taxed on the new value, and the property taxes are increased to $750,000.  In this example, the increase in property taxes from 2013 to 2014 would be $444,000 and since your firm occupies 10% of the building, you’d get handed a bill for $44,000.  And the fun part? You’ll get to pay that bill every year until your term runs out.

So is there any way to avoid this?  Yes, but it’s highly unlikely.  If you’re a large tenant in a soft market, you may be successful in negotiating “Prop 13 Protection” into your lease, whereby any “Due On Sale” taxes cannot be passed through to you.  Building owners are extremely resistant to agreeing to this, however, as it adversely affects the selling price.  Another strategy, if you know a sale is imminent, is to try and get your Base Year set to the year of the anticipated sale which could be achieved in a new lease or upon a renewal.

For everyone else, it is crucial that you do your homework before signing a new lease or renewing your existing one.  Being well informed is the name of the game.  Assuming you do business in a market that continues to appreciate, the more time that has passed since a property’s last reassessment, the larger the increase will be upon a sale.  Think of it like a rubber band; the more you stretch it, the more it’s going to hurt when it snaps.

Knowing not only when the subject property was last reassessed but also the likelihood the ownership could change hands during your tenancy should be a top priority and can help you avoid egregious and unexpected pass through expenses that most all office tenants are exposed to.

San Francisco’s Mid Market and the “Twitter Effect”

twitterSo who’s to thank for surging rents in San Francisco’s Mid Market corridor? The technology sector, naturally, whose epicenter has steadily been migrating from Silicon Valley to downtown San Francisco.  Operating the business to be closer to the tech talent pool is a trend that represents a shift in the thinking behind where a company decides to set up shop.

The Bay Area’s talented engineering and programming labor pool doesn’t live in suburbia – they live in San Francisco.  So to attract and retain this highly sought after demographic companies have been migrating to or launching in SoMa, Mid Market, Yerba Buena and the Financial District.  Now the City is in the throws of a commercial real estate boom that’s being fueled by technology tenants (who were single-handedly responsible for leasing over 1/2 of the 10.9 million square feet leased in 2012).

As SoMa quickly began filling up, developers and landlords set their sights on the short stretch of Market Street from 5th to Van Ness, and began to buy.  What kicked off “The Twitter Effect”, however, was Shorenstein’s purchase of 1355 Market and their following announcement of Twitter’s relocation to their new acquisition.  The eponymous technology company also took advantage of an attractive rental rate and the Board of Supervisors’ 6-year payroll tax exemption.  They now call 215,000 SF at Market Center their home and have invoked “The Twitter Effect” by attracting many other notable tenants to the area such as Square, Call Socket, Dolby, Pinterest, One King’s Lane and Yammer (who signed a 79,000 SF lease at $48.00 per foot – 60% higher than Twitter’s $30.00).

Other  San Francisco tech leases tightening the market include:

  • Salesforce.com – 440,000 SF at the upcoming 350 Mission St.
  • Square – 327,432 SF at 1455 Market St.
  • Meraki – 110,000 SF at 500 Terry Francois Blvd.
  • Yelp.com – 98,144 SF at 140 New Montgomery St.
  • Splunk – 92,000 SF at 250 Brannan

So what’s an existing San Francisco tenant to do when their occupancy costs could potentially double upon their lease renewal?

Read: “Help! My Landlord Wants to Double My Rent!”