Office/industrial lease: asset or liability???

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All too often, tenants view their lease as a necessary evil that needs to be addressed every 3-5 years. This belief results in a passive approach which eliminates many potential opportunities for cost savings that could be generated by a sound, proactive strategy. Typically, a lease, with its inherent obligation to pay a landlord rent, would be a classic situation of a liability, but in many cases, this liability can be reversed to become an effective asset. How is this possible? It is possible because an existing lease is an on-going contract that was executed in the past, and if not changed it remains the same on-going contract and liability, but what if a tenant had the ability to change its existing lease?

Modifying an existing lease can be accomplished by the collaborative effort and mutual approval of both landlord and tenant through renegotiation. In view of the fact an early renegotiation is a voluntary process, which is not predicated by a pending lease expiration, the prerequisite for a successful renegotiation is that one party cannot be the proverbial "800 pound gorilla" and have all the benefits. Instead both landlord and tenant must forego the sometimes adversarial landlord vs tenant mentality and proceed with the goal of creating a win-win situation for both parties. This can be achieved if both parties honestly convey respective goals and utilize sound, creative strategies to find solutions that can eventually result in numerous benefits for both parties, regardless if the renegotiation occurs during a "tenant market" or "landlord market."

Both tenants and landlords will have respective reasons and goals to want to renegotiate, but the mutual "common ground" goal is the ability for each party to opt for certainty in both short term and long term planning. Opting for certainty is the historical proven best business method for managing income, expenses and growth, as opposed to speculative risk which sometimes does lead to rapid increases in income and growth, but all too often leads to rapid descent and failure. Early lease renegotiations are not very prevalent due to a non-proactive mind-set of trying to out guess the market coupled with apprehension of possibly missing a future opportunity; i.e., "leaving something on the table." This passive approach may restrict a tenant or landlord from realizing actual opportunities that can easily be created.

Why would a tenant renegotiate early as opposed to waiting until its existing lease is close to expiration? If a tenant is confident of its future existence and viability and believes its existing space will be suitable for the foreseeable future, there are many potential reasons, in addition to opting for certainty, to attempt an early renegotiation:

* Manage Short Term and/or Long Term Costs--depending upon how a tenant's existing lease compares to the then existing market and projected future market, examining the overall real estate costs for the combined time period of the remaining balance of the existing lease term and extended renegotiated term, may result in substantial future savings over the combined term.

* Early Remodel of Existing Space--if a tenant wishes to upgrade the efficiency and aesthetics of its existing premises, an early renegotiation should provide a landlord funded tenant improvement allowance that can be used in advance of the existing lease expiration date.

* Obtain additional lease flexibility, expansion rights and other lease provisions that may not be contained in the existing lease.

* Guaranty long term occupancy if the existing lease does not contain an option to extend.

It would appear that these tenant benefits may only favor the tenant, but these tenant benefits will actually be the vehicle to allow the landlord to enjoy a different set of benefits that are only made possible by the tenant's willingness to renegotiate, as follows:

* Opting for certainty by preserving the tenancy of a good credit tenant is the landlord's main objective, as opposed to having to re-rent space with a replacement tenant and incurring the costs Of potential vacancy, down time and tenant improvements for a new tenant (usually in excess of the allowance for a renewal/early renegotiation existing tenant) may be cost prohibitive and may never be recouped.

* By extending the tenant's lease term, the landlord diminishes the risk of having a tenant being lured to other premises, because if a tenant seriously examines the market "there always seems to be a better deal elsewhere," as another landlord may be desperate and offer a deal that cannot be refused.

* A landlord may have certain situations that are not apparent to the tenant or the outside brokerage community, that warrant an early renegotiation, but landlords do not want to take the first step of making the initial inquiry for fear of appearing too anxious. These situations may be the landlord's need to renegotiate due to: 1) needing an extended lease term to refinance or sell the property, or 2) the landlord's knowledge of pending future vacancy(s) in the building.

The end results of an early renegotiation may not be measureable until near the end of the extended renegotiated lease term, but the fact that both parties are satisfied at the time the renegotiation was consummated creates the "win-win" situation. An early renegotiation can take many forms and be "mutually beneficial in either landlord or tenant favored markets, as illustrated by the following cases of deals transacted by the writer of this article:

1) 33,000 sq ft tenant, occupying 50% of a 65,000 sq ft building, with 2 years remaining on its original 10 lease term was paying $4.00 per sq ft, per month in a $3.00 per sq ft market. The landlord had 2 years remaining on its original loan and due to the pending. 33,000 sq ft lease expiration could not refinance the property. Tenant had its remaining lease terminated and signed a new 10 year lease starting at $3.00 per sq ft, plus annual 2% increases. During the lease term the average market increases exceeded the 2% negotiated lease increases, resulting in a tenant savings of $800,000 during the first 2 years of the new term, plus an additional $2.3 Million savings for years 3-10 for a total savings of $3.1 Million. The landlord benefit was to have the building re-financed by keeping the tenant in place with a minimal tenant improvement allowance, and which enabled the landlord to achieve high market rental for the lease renewals of the other tenants of the building and remain 100% leased for the entire 10 year period.

2) 20,000 sq ft, ground floor tenant in a high rise building, with 2 1/2 years remaining on its original 10 year lease was paying $2.25 per sq ft per month in a $4.00 per sq ft market. The tenant needed to create more efficient space by remodeling a 35% portion of the premises and the tenant was not satisfied with the condition of the outdoor plaza common area entrance of the building and would have relocated if the plaza was not refurbished. The tenant elected to have its existing $2.25 per sq ft lease terminated and agreed to increase its rent by signing a new 10 year lease at $2.95 per sq ft, plus annual 3% increases. In addition the tenant received a $15 per sq ft allowance for the entire premises, which effectively amounted to $45 per sq ft for the space that needed remodeling and the landlord agreed to upgrade the outdoor plaza. In effect, the tenant paid $0.70 per sq ft more for the last 2 1/2 years of its lease term, in order to save approximately $1.00 per sq ft for the next 7 1/2 years, received an improvement allowance and had the landlord upgrade the outdoor plaza. In exchange, the landlord opted for certainty and retained a valuable tenant, especially in an uncertain market due to the economic downturn.

For both of these case histories, it certainly appears that each tenant's proactive spirit converted their respective leases from a liability to an asset by not accepting the passive status quo of their respective situations. While some earnestly attempted renegotiations are not consummated due to disagreement of terms, the proactive thinker will not be disillusioned, but will always adhere to the adage "nothing ventured, nothing gained" when considering sound real estate strategy.

Gary Wagmeister is a Principal of Lee & Associates-LA North/Ventura, Inc. specializing in representing tenants and buyers in the leasing and sales of office real estate. He can be reached at 818.444.4925 or by e-mail at [e-mail].