Are You Negotiating a Proper Lease?

By Gerald A. Porter, CresaPartners w Los Angeles
GlobeSt.com, Aug 31, 2004

Too often, tenants and their brokers gauge the success of a transaction primarily by the difference between the current market rent and the negotiated lease rate. However, by focusing solely on rent, a corporate tenant could actually stand to lose multiples of the negotiated savings--ultimately losing considerable money on total occupancy costs.

Among the hundreds of pages that make up most lease documents, there are at least 100 negotiable aspects that can lead to significant savings for tenants. These range from smaller items like monthly parking fees and rooftop-access rights to more substantial matters such as sublease rights and termination options. To maximize savings potential, tenants must negotiate all facets related to their company's circumstances. The following factors are crucial to the success of any transaction:

Accuracy of Space Needs Assessment. Is the assessment of your space needs accurate? For instance, are you sure that you need 30,000 sf over the five-year term or could your space be restacked more efficiently to utilize only 28,000 or even 25,000 feet? What about the potential for expansion or contraction over the lease term?

Base-Building Conditions. Have you identified the deficiencies of base-building conditions when comparing alternatives? If the owner is not held responsible, what is the tenant's cost to upgrade mechanical, electrical, or fire/life safety systems? A seemingly fair comparison of two buildings with the same quoted rent is not truly comparable if one requires additional expense for base-building upgrades.

TIs. How much of a tenant-improvement allowance will you need to build out the space, accounting for all non-construction- related costs? This is essential to negotiating accurate tenant-improvement dollars. If you are using project-management services, you can also negotiate the building owner's oversight fees.

Realistic Occupancy Date. When can you take occupancy? This estimate must account for all factors, including scheduling of design, permitting, construction, furniture delivery, technology installation and all other relevant vendors' work.

The best course of action for addressing these considerations is to enlist the appropriate expertise up front. Typically, when a company conducts a real estate transaction, project management is not considered until the ink is dry on the lease documents. Fortunately, more corporate tenants realize the value of bringing project managers into the initial phase of the process--the strategic phase--to assist in creating a stable foundation for cost savings throughout the transaction and the project. By helping to identify both short- and long-term space and infrastructure needs; assess building deficiencies; establish a project budget inclusive of technology, furniture, and relocation costs; and determine a realistic occupancy date, an integrated team that includes a project manager and a real estate advisor facilitates more aggressive negotiation and avoidance of costly mistakes.

Consider the following scenario: A company has signed the perfect lease. The space is in an ideal location for client visibility, workforce recruitment and current employee commuting. The 45,000-sf lease consists of a competitive rental rate that is $5 per foot below current market rates over a seven-year term, plus three months of free rent. At first glance, this equates to a $1.9 million savings.

However, problems arise when, logistically, the company is unable to meet the scheduled occupancy date. In fact, scheduling delays due to unanticipated permitting back-ups and furniture lead times have pushed occupancy out by at least three months, resulting in a loss of the negotiated free rent and a costly holdover penalty on the current lease. The company's situation gets only worse when it comes to light that it actually needed only 40,000 sf, not the 45,000 committed to in the new lease. And, upon closer review, the TI allowance negotiated at $20 per foot really needed to be $35. Taken as a whole, the perfect lease is not so perfect anymore.

In this example, the inaccuracies and improper planning tally up to major expenses. The 5,000 feet of surplus space at $30 per foot over a seven-year lease term equals nearly $1.1 million. At $15 per sf, the additional out-of-pocket tenant improvement expense comes to $657,000. And the cost of the lost free rent is another $337,500, not to mention the corresponding holdover penalty. That's a total loss of at least $2.1 million--more than eliminating the originally perceived savings. Bringing project management into the fold before negotiating the lease could have avoided much of this expense as well as the shock associated with the unraveling of the perfect lease. Clearly, this hypothetical--yet plausible--case study illustrates how project management's upfront involvement can not only increase cost-savings opportunities but also help avoid unnecessary expenditures and schedule delays.

Make no mistake, the importance of bringing project management into the due diligence and negotiating phases of the project in no way negates the importance of having an experienced corporate real estate advisor representing the tenant's interests. It is the early integration of project management and transaction services that generates maximum benefits. Combining the pre-planning expertise and management skills of project managers with the market knowledge and negotiating savvy of corporate real estate advisors generates efficiency, continuity and accountability. From strategic planning and transaction support through project preparation and execution, an integrated-service approach creates increased upfront transaction savings, decreases client-time involvement, mitigates risk, produces overall occupancy-cost reduction and delivers functional projects on schedule and within budget.

CresaPartners LLC vice chairman Gerald A. Porter is one of the firm's founding partners. He is based in the Los Angeles office, where he serves clients that include DreamWorks SKG, Amgen Inc. and BAE Systems.