It’s a complex process, negotiating a commercial real estate lease, but with the right planning, it can work to your benefit
1. Introduction: A Complex Process Needs a Solid Team
Unless your company is a multi-unit operator with an internal real estate team, negotiating a commercial real estate lease for office space can be a harrowing experience for your executive team. The stakeholders are many and varied, the consequences potentially long-term, and the investment can be substantial. What’s more, just about everything in a commercial real estate lease is up for negotiation—not just rent and term, but build-out, the ability to expand or contract, and termination options. “
“There is a lot more under the hood of a lease than just the rental rate or the economics,” says Ken Ashley, executive director and a tenant representative at Cushman & Wakefield in Atlanta. “In the U.S., the lease document is going to largely govern the day-to-day interaction between the tenant and the landlord.” The good news? With a solid team and thorough planning, you can negotiate a commercial real estate lease that meets your needs now and for years to come. “On their own, the average tenant doesn’t stand a chance,” argues Dale Willerton, principal at The Lease Coach, a commercial lease consultancy. “They’re negotiating against a seasoned real estate agent or a landlord who has 1,000 tenants.”
2. Define Your Needs, Not Your Space
A critical first step—before even looking for space or considering square footage—is to have a thorough understanding of how it will be used. “The landlord will want to know how much space you want, but that’s not the first question to answer,” says John McGowan, executive vice president, corporate real estate, at Regions Bank. “The first question is, how will you use the space? How many people do you want to be in it?” Even that question isn’t as simple as it sounds, though. “A lot of companies today are evaluating new workplace strategies that might involve denser workplaces with more people in less space,” Ashley points out. “While conceptually that sounds good, there is some real-life impact on the landlord and on the building, such as taxing parking ratios and elevators and air-conditioning systems used in ways that buildings weren’t designed for. These are just a few examples of things that need to be negotiated or understood before you approach the landlord.”
3. Build Your Team
“Because of how complex these agreements are, planning and negotiating a commercial real estate lease does require a team approach,” says Keith Pressley, who as senior vice president, corporate real estate at Regions, negotiates on behalf of the bank throughout its entire 15-state footprint. Adds Ashley, “You’re up against a professional landlord who is an expert in the market. You can level the playing field by having a good representative in your court.”
Core team members typically include:
- Architect. “Probably even before the broker, you need an architect or at least an interior designer who can guide you down the trail of how you’re going to use the space,” says McGowan.
- Broker. There are brokers, and there are brokers. Yours should be an expert in tenant representation. “It’s a misconception for a tenant to think that the real estate agent is trying to help them,” says Willerton. “With a $30,000 to $50,000 commission paid by the landlord at stake, the agent is trying to get the best deal for the landlord.” Even the agent engaged by the tenant typically shares this commission, he points out, so paying a representative to handle your side of the negotiation without conflict of interest is imperative.
- Attorney. You need a real estate attorney who is an expert in commercial real estate,’ McGowan continues. “There are a lot of attorneys who think they can do real estate, but you need somebody who specializes in it.” Even so, Willerton cautions, while an attorney is necessary to review the final agreement, lawyers do not necessarily make the best negotiators. Tenants turn to them simply because they’re conveniently available.”
- General contractor. “You have to build the space out at some point, and that general contractor must be good enough to bring other specialists on board as needed,” he concludes.
Other team members might include an insurance agent, an environmental consultant, and a project manager who would serve two roles: making sure the space is built out to your specifications and coordinating move management once the leasehold is ready for occupancy.
Finally, the team needs what Ashley refers to as an “internal champion” within the organization. “It is critical that the person who is leading that effort and the senior executives agree on what the need is,” he says. “That sounds simple, but I can’t tell you how many times deals fall apart at the board level because there was no clear alignment along the way.”
4. The Process
Once you’ve started negotiating, the process itself has some fairly clear steps, as outlined below.
Prepare an RFP
Once you’ve established your requirements and hired a broker, McGowan advises putting the project up for bid with a request for proposal (RFP). “This creates a competitive environment within that market,” Pressley says. “Even in the largest cities, commercial real estate is a small community. If you’ve got an RFP on the street, chances are other property owners know that you’ve asked their neighbor for a proposal.” Adds McGowan, “I think it creates a seriousness to the conversation as opposed to a phone call that says, ‘Hey, how much are you charging for rent?’”
Narrow the search
With proposals in hand, you can visit a few promising properties. “They all have attributes that are subjective and hard to quantify,” says McGowan. “Some have better locations, better traffic, a higher floor, etc., if that’s what you prefer. Parking is a huge issue these days. Is there enough parking for your employees and customers? Do they charge for it? There are a lot of softer areas that you really need to explore, and each property is unique.”
Negotiate flexibility
As crucial as thorough planning is, it is impossible to predict every contingency, which is why any good commercial real estate lease negotiation should take into consideration potential shifts in direction. “There are at least four areas that are key for flexibility in a lease,” Ashley says: “First is the ability to expand the space. Pre-negotiating the ability for a tenant to expand under agreed-upon conditions could be very valuable to a business.” Failing to consider expansion needs, he contends, is “the worst of all possible worlds.” Either you’re locked out because space isn’t available, or, if it is, you’re subject to prevailing market rates—or worse. “They already know that you’re a captive tenant, so you lose leverage,” he points out. We’re in a rising-rate environment. Every month that clicks by, it’s possible that office space gets more expensive.”
The second area is the ability to contract, which can occur via favorable sub-lease provisions, termination agreements, or other give-back strategies. Number three concerns physical alterations to the leasehold. “You may be entering into a 15-year lease, but workspaces are organic. They’ll need to change throughout the term,” Ashley notes. The final area of flexibility is the ability to assign the lease. “There’s a lot of activity in the M&A markets these days. If your company is bought or sold, you have to be able to assign the lease to the new entity. That doesn’t sound like a big deal until your deal is about to close, and you have an ‘uh-oh’ moment.” Willerton agrees. “The lease assignment clause is like a vital organ,” he says. Without a robust assignment clause, a landlord can use the occasion of a transfer to raise the rent or demand other concessions. “They’ve got you over a barrel,” he argues.
Calculate your budget
“The easiest part of the budget is the cost per square for the rental space itself,” says Pressley. “Any broker can tell you what you should expect to pay per square foot for downtown Birmingham, or Atlanta, or wherever it is. That’s easy. It’s the build out that starts to be difficult.”
Your budget therefore, must include not only rental, but the cost of adapting the space to your purposes as well. Many commercial leases include a tenant improvement allowance, which might be negotiable in relation to the monthly rent. A startup may prefer a higher allowance in exchange for a higher rent, while a more mature, well capitalized company may have the cash to invest in improvements in order to save on rent down the line. Bear in mind, though, that the landlord of a multi-tenant property will want to keep monthly rent within a prescribed range, so as not to have wide discrepancies among tenants.
“Most landlords stay within a range because what they don’t want is another tenant saying, ‘Oh, you’ve charged two dollars less per square foot to that company than you charged me,’” says McGowan.
Choose your term based on your outlook
Typically, the longer the lease, the more favorable the rent. “With a shorter lease, you’re paying for flexibility,” Pressley says, adding that the ideal term is one that reflects your business outlook for the operating unit in question. “Let’s say you’ve got an established business with a call center,” he posits. ”At some point, the call center will likely outgrow the space and you’ll need to relocate, but you can plan for that within a couple years, so it’s safe to deal with a longer lease term. Conversely, a new business unit has more uncertainty built in. “In that case, you’re probably better off paying a little bit more for the protection of being able to terminate that lease in a shorter period with less rent obligation,” he says.
Consider end-of-lease strategies
“The least expensive time to vacate a space is when the term is up,” Pressley explains, “so it’s important to analyze your future needs as you negotiate an initial lease. You’ve got to go back to why you want to leave: One reason you might want to leave is that you’ve outgrown the space. So when you enter the lease initially, you need to investigate what your growth opportunities are in the building. If you’re taking the last 5,000 square feet of space in that building and everybody’s got a ten-year term, you’re not likely to be able to get more space two years from now.”
An ideal commercial real estate lease, he points out, will remain renewable at an affordable rate for as long as you want to occupy the space. The reason is simple economics: “It’s always expensive to move—always,” he asserts. “Dividing your space over multiple locations is simply not efficient, unless they’re completely separate functions, such as a warehouse vs. a customer-facing location, or intended to serve different geographic markets.”
Typically, commercial leases hold the tenant liable for the full term, unless you’ve negotiated an early termination right—something Pressley says is more likely a part of a renewal negotiation than an initial lease. Other options at the end of a lease term include right of first refusal or right of first offer on adjacent space or adjoining floors that gives you that flexibility inside the existing building.
Consider the relationship
Finally, when it comes down to dealing directly with a landlord, Ashley recommends against drawing blood. “What many people forget is that this is not buying a loaf of bread. It’s actually entering into a multi-year relationship that supports your business,” he explains. The relationship with the landlord is really critical on a lot of levels, so be mindful in the lease negotiation of a scorched-earth strategy. It’s okay to leave a little on the table and invest in the relationship strategically.” He also advocates transparency. “While always being cognizant of preserving leverage, I think successful negotiators are clear in communicating their needs to the landlord and not into cute, last-minute tricks,” he says. “They have an acute understanding of the needs of the other side. Here’s an example: As a landlord, a life insurance company is interested in creating long-term value. By contrast, an entrepreneurial owner is interested in short-term cash flow. That means you are likely to get more free rent up front from a life insurance company, while you may want to spread free rent over the term for the entrepreneurial owner.”
A cordial relationship established during negotiations can reap benefits downstream. “Let’s say you have signed a lease, and it’s clear in black and white that this is what you have agreed to, but you actually need to do something different. If you have that good relationship with the landlord, and you understand their needs, sometimes all that’s required is to simply break bread with your landlord and ask the question. You might be surprised what the answer is.”
5. Lay the Groundwork
Negotiating a commercial real estate lease is a complex process that involves innumerable compromises. But a successful initial negotiation lays the groundwork for favorable renewals and a long, successful tenancy. What’s more, a strong lease can become part of the intrinsic value of a company, Ashley says, concluding, “As we enter the war for talent, having attractive space in a vibrant part of town can help attract and retain talent, spur productivity, and enhance your company’s image.”
