Help! My Landlord Wants to Double My Rent!

ScaredIf you’re an office tenant in San Francisco (or any other market where vacancy is plummeting), there’s no doubt you’ll probably face a substantial rent hike upon your upcoming lease expiration. Since 2010, rents in the City have risen 39% and in 2012 alone, 24%; representing the biggest gain of any market in the world.

Relocating your office can be expensive and disruptive to your business, so if your first choice is to stay and renew, here are a few strategies that can help mitigate the rental increase.  The days of passive negotiation are gone; you need to be proactive.

  1. Renew your lease as early as you can.  The sooner you renew, the lower your rate will be.  Unfortunately, your landlord is also aware of this and typically will not renew your lease if too much term is remaining.  They’d much rather have you come back to negotiate at a later date, when rents are higher.  Every ownership is motivated by different things, however, so it doesn’t hurt to begin the dialogue early. 
  2. Explore options outside of your building.  Even if you fully intend to stay, you need to get out in the market and see what else is available.  You cannot expect to have any negotiating leverage with your landlord if their property is your ONLY option.
  3. Explore options within your current landlord’s portfolio.  If you’re getting priced out of your current office space, perhaps there’s a less expensive option elsewhere in the building on a lower floor, or even within another building your landlord owns.
  4. Reduce your square footage.  One of the most effective ways to reduce your monthly operating expenses is to simply lease less space.  Identify inefficiencies within your current space and consider consolidation or reconfiguration.  Are there employees in private offices that could be just as effective in a workstation?  Could employees who are out of the office regularly share a common workspace? There also might be an opportunity to “give back” some space upon your renewal whereby the landlord carves out a section of your office and builds a demising wall, thus reducing your rentable square footage.
  5. Hire a commercial real estate advisor.  Your broker is the best source of market information, and when you’re well-represented, your landlord knows you have access to valuable market information and may potentially relocate if they don’t offer you a fair deal.  But your broker also knows something your landlord does: renewing existing tenants is cheaper for the landlord than signing leases with new ones. Should you leave the building, the landlord will temporarily lose rent while the space is unoccupied. Also, brokerage commissions and tenant improvement allowances are typically higher on new leases.  Your broker will quantify these costs, translate them into real numbers your landlord can understand and then make a business case as to why your renewal rate should be lower than their current asking rate.

Rental increases are a natural part of the cycle and being prepared and proactive is the best way to mitigate an inevitable rental hike.  Ultimately, you’ll need to weigh out the two options of either staying in your space and softening the blow, or relocating to a less expensive building or submarket.

See also: When is the Best Time to Renew an Office Lease?

5 Things Every Office Tenant Should Consider in the New Year

©2012 Darvin Atkeson / LiquidMoon.com
©2012 Darvin Atkeson / LiquidMoon.com

Over the years I’ve observed that for many tenants, once the lease has been executed it’s filed away and forgotten until it’s time to renew or relocate.  This is partially because they’re focused on their core business but also because they assume that once the lease is signed, the terms cannot be modified again until after the expiration date; this is simply not true.  Depending on factors such as a change in the building’s occupancy level, the general overall health of the local market, and even a change in the building’s ownership, improving the terms and rental rate could be achievable by the tenant as leverage may have shifted.  At the very least, a quick refresher will remind a tenant of key dates, their rights and options, or even a potential liability they’re currently exposed to.

As we head into the New Year it’s a good time to dust off your lease and ask your commercial real estate advisor to conduct a review and provide you with an updated lease abstract. Here are five things they should consider:

1.  Could your rental rate be immediately lowered?
If the rental rate you’re currently paying is substantially higher than where current market rates are, then a “Blend and Extend” strategy may be possible.  Simply put, you amend your lease to extend the length of your term, and blend the new lower rate into the present high rate, thereby immediately lowering your rent.  If your lease expiration date is too far in the future or you do not wish to extend the lease beyond that date, there could be other options as well.  Perhaps the landlord has a large security deposit on file, and you’ve made timely rental payments whose sum now eclipses the cost of the landlord’s up front occupancy costs (tenant improvements, broker commissions, etc.).  Albeit risk-adverse, savvy landlords understand that their tenants’ success is tied to their own.  Therefore, they may allow you to apply a portion of your existing security deposit towards rent, and in some cases just simply give some back.

2.  Are you aware of important notification and lease dates?
If you have the right to extend your term, the landlord typically will build notification dates into the lease.  For example, you may need to notify the landlord of your intent to renew no sooner than nine but no later than six months prior to your lease expiration.  This also goes for Early Termination, should you have that right.  Make sure to be well aware of when your lease expires, as well.  It can sneak up on you and if you don’t plan and time your renewal or relocation wisely, your leverage could potentially be substantially reduced.  Mark your calendar and stay ahead of these dates.

3.  Have you received and reviewed your Operating Expense Rent Statement?
If the landlord is passing through operating expense increases to you as additional rent, they should be providing you with an annual expense statement.  Don’t hesitate to ask your real estate advisor to review your statement for you.  If something is irregular they’ll catch it and perhaps recommend you exercise your right to audit, which tenants are usually allowed to do no more than once a year.  It’s also worth the effort to make sure expenses are not being passed through to you that were not agreed to in the lease.

4.  Does the size of your office still accommodate your needs?
Do not think that you have to “ride out your lease” if you’ve outgrown your space or perhaps have had to reduce the size of your staff.  Your real estate advisor can help you work with the landlord to relocate within the building into a more appropriately sized suite, and if one is not available, then subleasing may be an appropriate solution.

5.  What sublease rights do you have?
For many reasons, tenants often need to get out of their space in advance of their lease expiration date, and subleasing can be a wise exit strategy.  However, not all sublease clauses are created equal.  First, do you even have the right to sublease, and if so, what restrictions will be placed on you?  Are you allowed to sublease to existing tenants in the building, or tenants who have recently toured the building on a direct basis?  Can you market the space at any rate you set, or does it have to be equal to or higher than direct space in the building?  How are sublease profits shared and how much time does the landlord have to respond to a consent request?  Know your rights, and how the subleasing terms will likely affect the ability to achieve your desired results.

When several years have passed since you’ve signed your lease, it’s easy to forget what you signed up for in the first place.  Your real estate advisor can effectively and efficiently digest your lease, extrapolate key points, and then present them to you in a lease abstract within the context of today’s current market conditions.  This quick refresher is time well spent, and having a better handle on your lease’s key points and terms could prove invaluable for whatever may come your way in the New Year.

When is the Best Time to Renew an Office Lease?

There’s a bit of alchemy involved when concocting a recipe for the Perfect Renewal.  Factors such as the tenant’s size and credit worthiness, how much term is remaining on the lease, and the landlord’s position within the context of the overall market all play a key role in determining the best renewal strategy.

One of the first things to consider is the general direction the real estate leasing market is heading, from both a macro and  micro level.  Base rental rates typically escalate annually between 2.5-5% when you’re locked into a lease, therefore if market rents are outpacing that rate and will be for the foreseeable future, then a longer lease such as 5-7 years is advisable, from the tenant’s perspective.  If however rents are falling, then negotiating the shortest term possible (without forfeiting rights that would cause you to lose the space altogether) will allow you to renegotiate better and better terms until the cycle again finds the bottom.  This strategy runs counter to the landlord’s goals, however, as rental rate reductions cut into their bottom line.  The tenant’s broker must then identify other ways their client’s tenancy can benefit the landlord, and be able to effectively articulate and negotiate using them.

Many factors will play a role as to how far in advance of the lease expiration the tenant’s real estate advisor should begin dialogue with their client’s landlord, but the single most important factor is that there is enough time to locate, negotiate, and relocate to another competing property, even if the tenant’s goal is to simply stay and renew.  Commercial leasing is a business, and the tenant is the landlord’s customer who will pay a substantial amount of rent, over time.  It is only fair, then, that the tenant’s potential new transaction be brought to the open market where other landlords can compete for their business.

Fear of Loss is a powerful thing, and by touring the market and viewing alternative properties and perhaps even accepting unsolicited proposals from other buildings, the tenant’s landlord knows they must put their best offer forward or lose an income stream to another property.

There are of course many, many other factors that a tenant should consider when timing their renewal; tenant movement within the building, the landlord’s current fiscal position, and even competing landlords’ aggressiveness to “make deals”  (a landlord in the Jack London Square submarket of Oakland, California recently lured a 40k square foot tenant to relocate a year in advance of their expiration by offering them a full year of free rent).  Early renewals well in advance of the contract expiration are also typically achievable using a “Blend and Extend” strategy.

What’s most important is that the tenant hires the right commercial real estate advisor who knows the market cold, and does not underestimate the time required to implement a full real estate process so as to yield the absolute best terms possible.

See also:  Should I Hire a Real Estate Advisor When Renewing My Lease?