THE ART OF RENEWING YOUR OFFICE LEASE

If a firm or business rents space, rent is usually the second largest cost item after payroll. Today and throughout 2017, commercial office tenants in the Washington, D.C. Metropolitan area nearing the end of their lease term have a unique opportunity to dramatically reduce what they are paying their landlord. Costar, the leading commercial real estate database, reported DC Metro wide end of second quarter 2016 vacancy at nearly 15% with vacancy in many submarkets exceeding 20%. More than at any time in the last 10 to 15 years, Landlords are competing aggressively both to attract new tenants and to retain the tenants they have. We expect this trend to continue through next year.

To take advantage of this market, owners and chief executives of area businesses can either relocate or renew their existing lease. We will take a look at the decision to relocate in a later article. For the purpose of this article, it is assumed an office tenant leases space that still works well for its business in terms of size, location, and image. The goal of this tenant is to renew its existing lease with its existing landlord.

There is a definite art to renewing an office lease. It is not just a matter of asking the landlord for a renewal proposal, countering terms a few times, and then executing a lease amendment extending the lease term. By using these tips, tenants can achieve the lowest rental rate and the most concessions from the landlord.

START EARLY.

The renewal cycle should begin 12 months before the end of the lease term. The tenant should initiate the renewal process by a written request to the landlord for a renewal proposal. In no event should the tenant wait for the landlord to send a proposal. The goal in dealing with the landlord is to maximize the tenant’s options and leverage vis-à-vis the landlord even if the tenant really has no intention of moving. A relocation typically takes four to six months to complete depending on the amount of work that needs to be done to the new space. If the tenant waits until late in the lease term to begin renewal discussions with its existing landlord, the landlord will know the tenant has few options and in all likelihood wants to renew in place. The tenant should aim to complete the renewal negotiations no less than four to six months from the end of its lease. That way If renewal negotiations break down, the tenant can still relocate in an orderly and competitive manner. Another downside to waiting too long is if the tenant fails to renew or to complete a relocation before the end its current lease term, the tenant is usually penalized by the “holdover rent” provisions in its existing lease. Holdover provisions are included in almost all commercial office leases and typically require the tenant to pay 150-200% of its then existing rent if the tenant holds over past the end of its lease term.

REVIEW THE EXISTING LEASE.

It is common for leases to include a right to renew the lease term. If so, the renewal provision usually requires the tenant to exercise that right by written notice to the landlord within a stated number of months from the end of the lease term. The method of establishing the renewal rate should also be reviewed. If the tenant did its homework when it signed the initial lease, the renewal process will include a negotiation period between the tenant and landlord. The renewal rate should be pegged to the then market rental rate including market concessions from the landlord (free rent, tenant improvement allowance, etc.). If the landlord and tenant fail to agree on the rent and concessions within the stated period, a “three broker method” is often used to set the rent. Each side picks an “expert” and the experts then pick a third who come to a binding decision on the rent package. However, some leases provide in no event will the rent be less than the existing rent, or worse, that the renewal rate will be two to three percent higher than the then existing rental rate. Even if the lease includes provisions like these, the tenant may find the landlord is willing to waive the provision, especially if the building has a lot of vacancy—it is a tenant’s market.

MAKE THE EXISTING LANDLORD COMPETE.

The tenant must make its existing landlord believe it could lose the tenant. Landlords count on “tenant inertia”—they know relocating is disruptive to the tenant’s business and expensive. Consequently, it is not uncommon for an existing tenant to be offered a less competitive rent package than a new tenant the landlord is trying to entice into its building. This point is closely tied to the fourth and final point.

USE A BROKER.

Yes, this article is written by a broker, but using a broker is important and essential to making the landlord compete. Tenants typically negotiate a lease every 3, 5, 7, or 10 years. Landlords, on the other hand, hire leasing agents and property managers who are negotiating leases, showing space and “in the market” every day of the week. Tenants have a real information gap:
• what is the best, most attainable rental rate,
• what should the landlord offer for improvements to the space,
• should the package offered by the landlord include free rent and how much,
• what is reasonable for rent and expense escalations.

A little research on the internet is not sufficient to close this gap. By hiring a competent broker, the tenant evens the playing field, and it informs the landlord that the tenant is committed to developing options to the tenant’s existing space. The landlord will then know it must compete with those options. The existing landlord need not and should not ever know that the tenant’s goal is really to renew its existing lease. Again, the object is to maximize flexibility and leverage for the tenant. A good broker will schedule and conduct tours for the tenant/client of available space in other buildings. This ensures the word gets out to the brokerage community, and specifically to the tenant’s existing landlord, that the tenant is “in the market”.

Finally, hiring a broker will save you time and money even taking into account the commission the landlord will pay the tenant’s broker. Not all, but most office buildings in the DC Metro area are institutionally owned—national or regional equity funds, real estate investment trusts, life insurance companies and the like. Each year these landlords budget for commissions, tenant improvements, and other concessions the landlords will need to make to lease their buildings. Based on first-hand experience, the landlord does not offer one price to a tenant with a broker and a lower price to a tenant who is not using a broker. If there is no broker, the landlord simply keeps the difference. In terms of concessions to a tenant, landlords pay what is “market” provided the tenant and its team have skillfully used the market to force the landlord to maximize the concessions by the landlord.

The only area this may be different is for a “Mom and Pop” type owner. However, even here, a good broker will be able to use the market to the tenant’s advantage.

Use these tips and watch your bottom line improve.

Rick Lane, Esquire is a former partner in a real estate and construction litigation law firm with extensive
brokerage experience representing tenants in northern Virginia, D.C., and Maryland.