A Tenant's Guide to Leasing Commercial Property
A company relocation or new startup space affects almost all aspects of operations. Yet, most companies do not have managers with experience in negotiating a facilities lease and leading the commercial real estate site selection process. Nonetheless, every few years companies must either relocate or extend their existing lease facing landlords with far more experience. A Tenant’s Guide to Leasing Commercial Property is designed to help level the playing the field for tenants by calling out common pitfalls to avoid, and processes to pursue that can help tenants make commercial property leasing decisions with confidence.
Commercial leases are typically one of the biggest corporate expenses and one of the more important, visible decisions a management team or business owner can make. The most common mistake companies make during a relocation is not involving enough company stakeholders and department heads early on to build internal consensus. Failing to define operational space requirements early on can lead to suboptimal results, unnecessary disruption, and unmet expectations. s early on can lead to suboptimal results, unnecessary disruption, and unmet expectations.
To minimize disruption and to get started on the right foot, here’s a sequential process and program that has worked time and time again for most companies facing a relocation or lease renewal:
1. Think holistically about real estate and how it impacts your business. Many companies have a business plan and ideally your company’s lease should be aligned to it as closely as possible. List your top goals as a business and then think how a new space or your existing facility works to help meet them. Create a real estate decision matrix with your management team to build consensus early, and to guide your commercial real estate broker. Here’s some of the issues for a relocation that often come into play:
Real Estate Direction Matrix
|No.||Site Selection Criteria|
|1||Preservation of existing employee commute patterns to work|
|4||The total up front cost of moving (leasehold improvements, furniture, fixtures, etc.)|
|5||Expectations that customers may have|
|6||Suitability of the space for operations|
|7||Flexibility for future growth|
|8||Proximity to amenities such as restaurants, gym, childcare, etc.|
2. Define the size of the space needed early on. Using a sample available property that meets most of your operational requirements, have a designer, architect, or furniture dealer create a space plan. Many vendors will provide this service for free in hopes of obtaining your business later on. This will help to flush out the size of the space required now and into the future as you plan for headcount and other potential changes.
3. Obtain the help of a good broker. Having a good broker on your team is absolutely key to a good outcome. Brokers will help navigate and position your requirement in the marketplace so that ideally more than one landlord becomes interested in having you as a tenant. Work with your broker to produce a shortlist and then go back and forth between the buildings until you start to see the pluses and minuses of each opportunity. Broker fees are paid by landlords and you are not going to get a better deal from a landlord because you don’t have a broker. The landlord has a vested interest in obtaining the highest rental rate regardless if you have a broker or not. Plus, brokers track all the spaces available in a market and can cut out a lot of unnecessary cycles for business owners and executives trying to use the Internet to go it alone. Brokers can also help you avoid unscrupulous people and buildings with known issues.
4. Start early and put together a preliminary moving schedule. Don’t wait until the last minute to start looking for space. It always takes longer to find the right space, to negotiate a lease, and to equip a new facility for operations than most people think. You don’t want to be rushed through the process and forced into making hasty decision because of some pending deadline or the end of an existing lease with costly “holdover” provisions. If the market is tight and options few, start your process even earlier to allow time for more options to develop. Create a move timeline or schedule with your broker to work against. Include design time, obtaining building permits, procurement of equipment and services, construction periods, and furniture assembly and fit-out. If heavy construction is anticipated than start looking at new buildings 12 months in advance of when you need to be in the new building. If the space requirement is small and no construction is involved, start looking about 4 months from when you need to move. If some construction is potentially involved, or the market is tight, start looking at least 6 months in advance.
5. Obtain preliminary approvals to proceed. Do you need board approval to sign a new lease? If so, work with your broker to create a detailed financial analysis for various target buildings based on market comps, and various assumptions qualified by your broker. If necessary, meet with your management team and board members to obtain feedback and commitments to proceed based on the various scenarios presented. This will quickly identify the type of space and deal structure ideal for your company, and what ultimately can be approved.
6. Start the RFP or LOI process. Ask your broker if it is better to start with a request for proposal (“RFP”) process, or move immediately to a letter of intent (“LOI”) for each building owner on your short list. Each market is different with varying customs and business practices. So that you are taken seriously in the marketplace, only choose buildings that you would realistically move into if adequately motivated to do so by the landlord. Your RFP or LOI should include the following basic business points among other things:
- Ideal lease term
- How the space is to be delivered by the landlord
- Proposed occupancy date
- Leasing concessions such as free rent, a tenant improvement allowance, moving cost allowance, furniture allowance, early lease termination provisions, etc.
- Options to extend the lease
- Sublease/Assignment provisions
7. Start lease negotiations. With hopefully attractive lease proposals in hand from one or more landlords on your short list, work with your broker to put together non-binding counterproposals and LOI’s based on market conditions and the other transaction elements received from other landlords. Rely on your broker for guidance on what levers to push, and how to be aggressive with each landlord without being so much so that your offer is not taken seriously. Consider needed flexibility such as early lease termination provisions, expansion options, and automatic renewal options to incorporate those into your proposals. If there is a considerable amount of construction involved and other leasehold improvements, it would be a good idea to develop your own tenant improvement budget to help guide negotiations.
- After reviewing responses back from the various landlords to your counterproposals, it is time to get your senior management together and review proposals to determine the finalists based on you and your broker’s recommendations. Update earlier financial models and be prepared to address a series of questions regarding anticipated costs, risks, rewards, and why these buildings are better than any of the others you looked at or received proposals on.
- Prepare your final and best non-binding counterproposal(s) asking each landlord to include a draft lease with its response. If you like one building more than any of the others (this happens most of the time) you should consider asking the landlord to take the building off the market as you negotiate a lease in good faith. Obviously at this point you only want to be negotiating on buildings that you can realistically move into on time and on budget. The counterproposal stage may go a few rounds and include verbal negotiations. Work with your broker to ensure that you have an executed non-binding term sheet that the parties can rely on to review the lease against.
8. Obtain legal assistance. Using the final term sheet, engage your attorney to help with the review and negotiations of the lease document. Use your broker and attorney to determine what is “market” and what to try and change in the lease. Depending on the size of the lease commitment and dollars involved, you may wish to cap your attorney’s hours and involvement. Gather your team’s concerns with the lease and have your broker relay those concerns to the landlord by providing the landlord a redline against the original lease. Usually a conference call with all parties involved is best after initial lease comments have been distributed. Where should you focus your energy? The following lease terms are important and should certainly be reviewed and understood clearly:
- the base rent and rental escalations if any
- all expenses associated with operating the building and who pays for what expenses
- who handles building repairs and how those expenses are paid for
- the treatment of future capital improvements
- the payment of real estate taxes and insurance expenses
- the tenant work letter and how the building and space will be delivered to the tenant
- building use provisions including rules and regulations
- sublease/assignment rights
- tenant audit rights with respect to building expenses passed through to the tenant
- determining fair market rent for options to extend the lease term
In many cases tenants will elect not to use attorneys for small leases. If so, pay attention to the above clauses and make sure you are dealing with a highly reputable landlord.
9. Complete your due-diligence. As you work through the lease document, it is time to carefully review the condition of the building you may end up living in. How much due-diligence to apply is often dictated by the total size of the financial commitment involved, the lease structure (triple net or NNN, gross lease, or full service lease), the age of the building, and the warranties available. For example, if the lease structure is triple net (NNN), which forces the tenant to be responsible for the electrical and mechanical systems servicing the building and the roof membrane, it is important to inspect the building similarly to how home owners conduct inspections of the homes they purchase. If you are the single tenant or about to take on a lot of space, you may wish to have the roof inspected or see if has recently been inspected and what the outcome was. Determine if the roof leaks, the useful life remaining on the building systems, and if the building has been well serviced or if there is deferred maintenance. If the building is occupied you can certainly talk to the tenants and see what they have come to find. If you are planning structural changes to the building and other improvements that will involve permitting, be aware that these will trigger an audit of the building by the city municipality to determine if the building has all the necessary life/safety equipment and is in compliance with other building codes. Make sure to understand what will be required to obtain approved occupancy status, and who is going to pay for what if code compliance issues are triggered by planned work to the building.
10. Work in parallel with vendors to move into the building on time. Ideally you want to shut down on a Friday at your current location and open on a Monday in the new location. To do this you will have to plan ahead to avoid painful disruptions and delays. While negotiating the lease document and completing your due-diligence, you will likely need to set into a motion a series of events so that you can move into the building on time. This might include provisioning telecommunications and data circuits, selecting contractors, receiving bids for work and equipment, generating quotes from furniture dealers, and arranging for the provisioning of various services. Put yourself in a position to pull the trigger on multiple decisions in parallel working down to granular details such as ordering business cards, changing your mailing address, updating your website, and sending out “we have moved” announcements to your customers and their billing departments. Finding and securing the perfect building for all the right reasons is obviously the goal here, but sometimes that’s not always possible and in fact most of the time, it is not. Concessions are often required and expectations reset after finding out that what you want in a perfect world, just isn’t possible. Make these adjustments early and your site selection process will go much smoother as a result. Clearly this guide doesn’t pertain to everybody and for the smaller leases very little of it is applicable as the dollars involved just isn’t worth the drama of a lengthy lease negotiation. I hope this guide serves you well and we appreciate your use of BuildingSearch.com.