Well in advance of the date you move into your new office, you should be thinking about how to structure the terms of your lease in order to avoid problems further down the line, according to commercial real estate experts. Numerous factors need to be considered, from pinpointing the size, type and location of available space, to setting a budget, negotiating a contract and timing the various stages of build-out. The variables of leasing transactions are considerable, particularly for a first time lessee.
Before you sign a lease, carefully investigate its terms to determine whether it fits your needs. Make sure you can afford the rent, and don’t forget to include extra monthly costs such as utilities or maintenance charges. Consider the length of the lease — it may be cheaper per year to sign a long-term lease, but your business may grow faster than expected, or the location may turn out to be less than ideal. Think carefully about the physical space — can modifications be easily made if necessary? Does it comply with requirements mandated by the ADA (Americans with Disabilities Act)? Find out how the landlord measures the space, since you will be paying by the square foot. It may be worthwhile to do your own measurements or contract with a professional to give you an exact figure. How much of the space is useable and how much is common area such as hallways, rest rooms and elevators?
Few companies are lucky enough to move into previously leased space without having to make some changes, and space in a new building will need to be customized to fit your needs. Make sure you know who is responsible for the cost of tenant improvements, modifications and fixtures, and who will own them after the term of the lease expires. You can choose to make changes yourself and be reimbursed by the owner in the form of a fixed sum of money called a tenant allowance. In that case, you will be required to coordinate all aspects of the construction project yourself, which may require more work, ready cash and expertise than you can provide. On the other hand, it gives you more control over the finished product, and can be less expensive if you bring the project in under budget. The alternative is to negotiate with the landlord to build out the space before turning it over to you. You will then be charged an additional fee per square foot for the improvements.
“The most common mistake tenants make is waiting too long to get started with the whole process,” said Randy Broadhead, senior vice president in the office leasing department of CB Richard Ellis. “When you do that, you limit yourself to previously built-out space and you give the landlord more power. You need to begin looking six or seven months in advance of when you want to be in your office.”
According to Broadhead, it takes about two weeks for a prospective tenant to review existing office space and determine what will suit his or her needs. From there, he said it takes an average of one week to get request for proposals (RFPs) back from the landlords of each space in which he or she is interested, and then three to four weeks to negotiate a proposal.
“It takes another two weeks to select business terms and start space planning, then an additional two weeks to finish the plan, estimate costs and make sure it comes in within budget,” explained Broadhead. “It takes another two weeks to negotiate the lease document. Tenants may have to meet with the contractor [regarding tenant improvements] and make compromises to stay in budget. Revisions mean additional time is needed.” Added Broadhead, “Next comes the lease negotiation with all parties involved, which averages about four weeks, then the permitting process, which, prior to the preliminary plans, will require working drawings. After that comes the actual build-out, which averages 45 to 60 days.”
Broadhead noted the necessity of utilizing a broker in lease transactions, pointing out that experienced brokers understand landlords, know the local market, the prevailing options and concessions and can assess the pros and cons of various locations. Said Broadhead, “Without a broker, you can get a really bad deal and not realize it until much later.”
David Afromsky, broker/salesman for Colliers International, echoed Broadhead’s comments on the value of brokers in office lease negotiations. “We can pull all available properties, and with the technology available, we can target certain types of buildings and meet a client’s criteria to the penny,” said Afromsky. “Of course, it’s a two-way street. The more information prospective tenants can provide us, such as their size requirements, what their needs are, their signage requirements and timetable, the easier it makes the job.” Added Afromsky, “Tenants also need to be realistic. Budget is always a big question to take into account. What needs to be included? Tenants always underestimate. Ninety-nine percent of the time we end up educating the tenant on the entire process.”
Afromsky also noted that a business owner trying to negotiate a lease without a broker runs a risk of being taken advantage of by a landlord. “The landlord’s representative will try to get as much as possible per square foot. If they know you don’t have a broker, they’re going to quote you the rack rate. Many first-timers working without an agent also need to know that if they’re looking at brand new build-out space, there could be overages, plus the typical moving costs, such as security deposits and first month’s rent. They need to be cognizant that new build-outs are not done turnkey.”
While Don Haze, vice president and managing broker of Grubb & Ellis/Las Vegas, noted that a broker is there to help the tenant make the best possible deal, he also pointed to a number of issues tenants need to take into account when they’re negotiating an agreement. These include the role a tenant’s previous business history and financials have in setting terms. “A key issue is to make sure the landlord is being fair and that there are no surprises from the property management company,” said Haze. “The landlord will want to examine your business history and your financials. A landlord can jack up the price if you’re considered high risk. This is where a good broker, accountant and attorney can help.”
Haze said it’s also important to make sure vesting, or the name on the lease, coincides with the name on the business license and that the license itself is compatible with the building’s intended use. He also warns prospective tenants to be aware of clauses in the lease that concern assignment and sub-leasing, and how onerous the clause is in the event the tenant needs to get out of the lease.
“When it comes to tenant improvements, or ‘TIs,’ there are several things a tenant needs to be aware of,” said Haze. “Normally speaking, your financials determine what you can get and how specific you can get. Questions that also need to be asked include: Is air conditioning distributed throughout as space? If not, who is responsible for the cost? If the business is run on weekends, will the air conditioning be turned on? If so, what is the cost? How will overages be handled? A tenant considered financially weak may be asked to pay cash; for others, costs can be amortized. Tenants should also avoid too many special improvements to a space, because that can make re-leasing or getting out harder to do.”
According to Judi Woodyard-Suntik of Lee & Associates, the lease market for Class A office space is currently good, and supply is low with a vacancy rate of 6.03 percent. Rents are approximately 25 percent higher today than they were eight years ago. Lee & Associates project increased demand for office space, estimating the need for an additional 750,000 square feet of Class A space in 2001-2002, with anticipated vacancy rates remaining at 6 to 8 percent. In the Class B market, the company predicts demand for approximately 2.4 million square feet of additional space in 2001-2002, with vacancy remaining at 10 percent to 11 percent.
Companies considering moving into these spaces, whether they are new or already built out, would do well to consider asking for professional advice before they begin their search. A broker not only provides expertise, but he or she can negotiate on your behalf. Many terms of a lease are open to negotiation, including the length of the lease, rental rate, free rental allowances, tenant allowances/leasehold improvements and security deposits. It may take time to find the perfect space and the perfect lease for you, but it will pay off in a healthier bottom line for your company.
Glossary of Real Estate Terms:
Absolute Net: Lease that requires the tenant to pay all costs (including rent) associated with the operation, repair and maintenance of the building. This includes real estate taxes, utilities, repair and maintenance. Also referred to as net-net-net (NNN) or triple net.
Additional Rent: Money due under a lease in addition to base rent, such as operating expense increases.
Allowance: A landlord-determined dollar amount to be used by the tenant for a specific purpose, such as tenant improvements.
Amortization: Debt payment through installments of principal and interest, as opposed to interest-only payments.
Assignment: A transfer to another party of property or rights to said property (transfers of title). Examples: leases, mortgages and deeds of trust.
Base Building: The existing condition of a building prior to tenant improvements.
Base Rent: Dollar amount used as a minimum rent in a lease.
Common Area Maintenance (CAM) Charges: Charges for maintaining the common areas of a building.
Commencement Date: Date lease begins.
Contingent Fees: Fees paid in the event of a future occurrence, such as attorney fees, a broker’s commission, etc.
Certificate of Occupancy: A statement issued by a local government verifying that a building is in compliance with all necessary codes and is ready for occupancy.
Equivalent Level Rate (ELR): Flat rate per square foot that will equal the same total present value as a proposed lease’s variable cash flows.
Escalation: A clause in a lease providing for an increased rental rate at a future time.
Estoppel Certificate: Prevents individuals from asserting facts different from those contained in the document. Tenant and landlord both sign the document to confirm the facts pertaining to the lease.
Expansion Option: Right granted by the landlord which provides the option of adding more space to the premises.
Expense Stop: Fixed amount in a lease that serves as a “cap” or limit on the amount for which the tenant is responsible, in the event expenses exceed a pre-stated amount.
Extension Option: Agreed continuation of occupancy under the same conditions as outlined in previous agreements.
Fully-Serviced Lease: Lease in which rent includes coverage of operating expenses and taxes for the building.
Gross Up: Adjustment made to operating expenses to reflect occupancy levels in a building.
Ground Lease: Lease of land only.
Letter of Intent: Written statement of two parties to a prospective transaction (buyer/seller or lessor/lessee) stating intent to proceed to a final agreement in good faith on outlined terms.
Load Factor: Multiplier to a tenant’s useable space of a building’s common area, expressed in percentages.
Master Lease: A lease controlling subsequent leases.
Modified Gross: Typically, it is similar to full service; however, operating expenses, taxes and insurance are included in the tenant’s rent. Utilities, specifically electricity, and interior janitor service are not included. The covered expenses are controlled by either a base year or an expense stop.
Net Rentable Area (Same as Rentable Area): Specific square footage for which rent can be charged.
Occupancy Cost: Charge to tenant, pursuant to its lease, such as rent, operating expense increases, parking charges, moving expenses, remodeling costs, etc.
Reasonable Consent: Standard applied in a lease limiting landlord’s ability to withhold consent in its sole discretion.
Renewal: Right of a tenant to renew a lease at a rent to be determined (e.g.. 9.5 percent of “fair market rent”).
Request for Proposal (RFP): Document issued by a tenant’s agent to an owner, inviting submission of a proposal to the tenant for leasing of space. Document outlines the specifics of the lease term, expansion and renewal options, rental rate, tenant improvements and other allowances to be provided by the owner.
Right of First Offer: Right which gives the tenant the first option of buying or leasing occupied property if the owner decides to sell or lease.
Right of Offset: Specific clause in lease in which the tenant has the right to deduct from the rent costs which are incurred to the tenant from the landlord.
Space Pocket: Part(s) of a leased premises set aside to accommodate tenant’s future growth.
Sublease: Lease under which the lessor is the lessee of a prior lease of the same property.
Triple Net: Lease which requires tenant to pay property expenses such as taxes, insurance, maintenance, utilities, etc.
Turnkey: Owner makes property ready for a tenant to begin business.
Work Letter: Specifications for tenant improvements. Sometimes includes drawings, pricing and specific approval dates.
