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Negotiating corporate leases today.

Negotiating corporate leases today

Unlike earlier recessions, the brunt of the current downturn is being most keenly felt in the services sector which fueled the enormous growth of the nation's office markets during the 1980's. Despite the sharp decline in real absorption and the paucity of major new leases the market is not inactive. Many corporate tenants are grappling with how best to reduce their occupancy expenses necessitated by actual downsizing of their operations while a smaller number are scouring the market for sharply discounted rental opportunities.

Focusing on base rent is always important but it is only one component of the basic terms of a lease. Perhaps, one of the most important items, options for renewal or expansion are often reduced to secondary importance, if not completely overlooked. Recent events in the economy suggest that tenants become more attuned to this area of lease negotiation.

The securities industry provides an excellent example. It is notorious for sharp bursts of employment expansion in a bull market with sizable layoffs in a slumping market. The lack of market sophistication with regard to options is surprising given the complexity options play in this business. While it is reasonable to assume that such space users will never be able to precisely forecast their future occupancy needs because of external market forces the selective use of options could protect them in an expanding or contracting market.

Most companies are best able to project growth or other changes in, at best, five-year intervals. Large tenant leases, because of the cost of tenant improvements and other logistics, argue for minimum lease terms of at least ten years. Therefore the key option clauses come into play after the tenth year when growth forecasts become hazy. Moreover, after the initial 10 years, landlords can afford to be more flexible.

Market conditions often affect a tenant's leasing posture. For example, in today's market many tenants are confronting at best a stabile space requirement if not actual contraction. In considering a new lease or renewal, the last thing on a tenants mind is aggressive expansion options. The present climate, however, is the best time for a tenant to negotiate generous expansion provisions. It must be remembered that such options don't require current increases in occupancy costs and do not have to be exercised. They merely enable a tenant to position itself favorably for changed circumstances.

Contraction options, are rarely raised by the tenant and even more infrequently negotiated. The oft-cited reason for this is adamant opposition by the landlord and its mortgagee. It is also, I believe, due to the reluctance or unwillingness of the tenant to conceive of such a future eventuality. Large, credit-worthy tenants should not underestimate their negotiating strength in the current marketplace. Implementing a contraction clause can be very useful to a tenant confronting an unforseen slowdown or other conditions that mandate reduced occupancy requirements.

The economic effect of well-drafted option clauses could have a significant effect on long-term occupancy expenses. While they will be most beneficial to companies in industries that are cyclical in nature they also strengthen the facilities management flexibility for all major office occupants.

Delmhorst & Sheehan, Inc. is a real estate advisory firm serving corporate, institutional and non-profit clients in real estate acquisition, sale, valuation, leasing, strategic counseling, portfolio analysis, and financing.
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Title Annotation:Review & Forecast Section III
Author:Sheehan, John E.
Publication:Real Estate Weekly
Date:Jan 29, 1992
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