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Strategic planning for lease renewals.

The vast majority of office leases signed every year, in every market, comprise renewals or extensions of existing leases. This fact reflects the multifaceted at-fractions to tenants of renewing their leases. Chief among these is the avoidance of the substantial costs and operational disruption associated with relocation. Another is the opportunity to "play the market". If local market conditions are softening, for example, a short-term renewal permits a tenant to remain in place, and postpone making its long-term commitment, until market rentals have dropped. Also avoided are the nuisances of changing stationery and communicating a new address to business contacts. When a lease is expiring on facilities that are expected to meet future operational requirements with little or no physical renovation, the incentive to renew is powerful.

Most tenants, however, do not approach the renewal negotiation from a strategic perspective. Negotiations are often ill-informed or poorly timed. Sometimes, the renewal is not negotiated at all. These are costly errors, which guarantee an above-market rental for the renewal period. Sophisticated tenants, in contrast, will approach a renewal with the same level of strategic planning that would guide them in a relocation or, for that matter, any other major financial commitment. An effective strategy is especially critical in market environments where the existing rent is below current market value, and a renewal will inevitably trigger a significant increase in rent.

The key components of an effective renewal strategy are Professional Representation; Optimum Timing; Market Research; and Competitive Bidding. It is not unusual for tenants to slash 20-30% off the landlord's asking rent, simply by following a strategy based on these four elements.

1. Employ a Third-Party Professional to Negotiate with the Landlord.

It is often said that, "A lawyer who represents himself has a fool for a client." This holds even more true for the office tenant, with expertise in some field other than real estate, who attempts to negotiate directly with a landlord, whose only business is real estate. The mere introduction of an experienced broker or consultant immediately puts the landlord on notice that market realities will not be ignored, and that the tenant will be professionally represented in all aspects of the upcoming negotiation.

* Begin Early Enough to Maintain Flexibility and Leverage.

Landlords know that it usually takes 12-18 months to negotiate and implement a relocation. When a tenant opens renewal negotiations with only a few months remaining on its lease, it signals the landlord that renewal may be its only live option. A "captive tenant" has virtually no negotiating leverage, since it has foregone the flexibility to shift gears and move elsewhere.

* Identify Market Conditions to Establish a Baseline.

What is the space really worth? The market value of any unit of office space is a function of transactions recently completed for comparable space in similarly located properties. Critical information about such transactions include rent, buildout allowance, rent abatement and lease term. Part of the broker/ consultant's role is to research the relevant market conditions, and to thus establish the financial parameters of the renewal negotiation.

The negotiation baseline should be determined by the value of the space to the landlord, not to the tenant. If the space was to be rented to an outside tenant, what rent could the landlord reasonably expect to realize, after deductions for expenses? For example, if the market dictates a landlord contribution of $20 per square foot toward tenant improvements, and a renewal would not require this expense, the rent for a ten-year renewal should be approximately $3 per SF lower than the market rent. Marketing costs and rent abatement are other expense deductions that should be considered. The landlord should also be reminded that market risk will be entirely eliminated by a renewal, and that there will be no interruption in occupancy.

* Identify Relocation Alternatives to Create a Competitive Environment.

A competitive environment is crucial to an effective negotiation. This is established by identifying, pricing, and sometimes even negotiating viable alternatives to renewal. The landlord cannot be expected to negotiate seriously unless it is made clear that the tenant can, and might, take its business elsewhere. Even when the tenant has absolutely no intention of relocating, it is wise to identify one or several "stalking horse properties" against which the landlord must compete.
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Publication:Real Estate Weekly
Date:May 16, 2001
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