fbpx

5 Biggest Mistakes Tenants Make When Renewing an Office Lease

Lease Renewal Mistakes

Now more than ever, tenants are choosing to renew, rather than relocate, their offices. The mistake that many companies make is that they think renewal is not a negotiation. At its core, your lease is a financial commitment that your company is making. It is your right to negotiate the critical financial terms because they add up to real dollars throughout the term of a lease.

So, without further ado, here are 5 of the biggest mistakes tenants make when renewing their leases on their own.

1. Real Estate Taxes- Keeping the original base year

While I have written extensively about this topic, It’s All About The Base, on my blog, it’s important to highlight this, as it’s a crucial component of the financial deal you are making in a lease.

Let me start by first explaining real estate taxes in office spaces. After your first year of being in a new space, you are responsible for your proportionate share of increases in the office building’s real estate taxes. You are also responsible for your proportionate share of increases in the office building’s real estate taxes. The real estate taxes are based upon the revenue, assessed value, and budget that the building generates. This amount can range from a few cents per square foot to more than $1 per square foot annually. The kicker is that this number then increases cumulatively, so much so, that after 5-7 years of a lease, your taxes could be $4-7 per square foot (or higher). 

Now imagine that it’s renewal time and you are about to sign a new lease in your building. Who do you think the landlord wants to pay the increases in real estate taxes? That is right, you! They will attempt to achieve this by keeping the real estate tax base year from when you moved in. Why? Because if they do not, they then must pay those accumulated increases.  

Ideally, what should your new lease have? A new base year established, based upon the year you are starting the new lease, so that:

a) You should not have to pay any increases for the first 12 months

b) You should start back at zero and then the proportionate share of increases starts small again, and in many instances, is a nominal fee for at least the first few years. 

After all, if you were moving to a new building you would have this, so you should have this in your renewal as well.

2.Operating Expenses- Keeping the original base year

Each year the cost to run a building increases, from the insurance for the building to the staff’s wages that operate it. However, if you have a direct operating expense, please listen up. (This does not apply for fixed annual percentage increases). The annual increases can be from 5% to 4% based upon the building, and they vary from year to year. So, imagine if the expenses of your building were $15 per SF and each year the expenses increased by 4%; that would be 60 cents per square foot that increases cumulatively so that by year 5, you are paying $3.25 per SF in operating expenses!

Year 1$151.04$15.60
Year 2$15.601.04$16.22
Year 3$16.201.04$16.87
Year 4$16.871.04$17.50
Year 5$17.501.04$18.25

If you did not negotiate a new base year renewal and you are in 10,000 square feet of space, that could be an extra $32,500 per year, that over the next 5-year renewal, could be $150,000 that you could have saved if you had negotiated new base years.

3. Keeping the same amount of security deposit

The security deposit plays several roles for the landlord. It helps protect against lost rent in the case of tenant default and helps securitize some of the landlord’s upfront costs at the start of a new lease. These include transaction costs, like the free rent that is given up-front initially, as well as the money that is spent on building-out space (from adding a few offices to gutting and rebuilding a new space from scratch), also known as tenant improvement dollars. 

Essentially the landlord is trying to protect their investment. Additionally, when a company relocates into a new space, they are establishing a new relationship with a landlord. Everyone is trying to get to know each other and the landlord is trying to understand if you will be a “good” tenant that pays their rent on time.

In a renewal, there are many more known factors that remove the uncertainty that existed up-front in a first lease. While there are still some transaction costs, like free rent and perhaps some construction dollars spent (albeit most likely not as much), the landlord’s cash outlay is not as large, and therefore not as many needs to be protected. Additionally, you now have an established “relationship,” meaning you have paid on time, presumably for several years, and that should remove the initial concerns about your tenancy and flight or non-payment risk.

All of these factors should result in a lower security deposit that needs to be negotiated up-front rather than waiting for the lease amendment to be drafted. Use the negotiating leverage up-front rather than waiting until you have agreed to terms with the landlord.

4. Thinking they know the market

Just because a tenant has received a few calls about current availability in the building, does not mean that paints a picture of the market. Asking rent of $60 per square foot for an available space in the building does not mean that $60 is the right number for your space. A renewal is incredibly valuable to a landlord, and a value can be attributed to that. Renewal means the landlord avoids the lost rent during the period the space is vacant, which can sometimes be 3-12 months depending on the environment. Additionally, suppose you have been in your space for a while. In that case, a renewal enables the landlord to save money on the construction costs that may be required for a new tenant with a different requirement for their office layout (from several offices to the size of conference room space). All of this adds up to real dollars, that in part, should be reflected in some discounted base rent to the current “market” for new space in the building.

Then there is the market outside the building. Agreeing to a renewal in their building, because there is no increase from the last lease, is not a reason to renew. What if there has been a change in the market and vacancy rates in the area have increased? Or, what if the landlord in the new building across the street is being incredibly aggressive to lease their space and will offer a 15% discount to your building? Without exploring the market and educating oneself about the opportunities that exist, a decision about the landlord’s lease renewal proposal’s value cannot be made.

5. Assuming you have a “good” relationship with their landlord.

Remember, being a tenant in a landlord’s building is not a personal relationship, it is a working relationship. And if it is a “good” relationship, it is because you pay your rent on time. You are not friends, and they usually only “like” you because your business’s real estate costs contribute to their ability to run their business smoothly. It is crucial to remember the person that you are speaking to for your renewal DOES NOT represent you. They represent the ownership of the building.

Putting a layer between your company and the landlord in the conversation of your renewal has multiple benefits, including having someone as a buffer to be able to ask the tough questions, negotiate for the best financial terms, create the perception that you are potentially leaving the building, leveraging the market outside the building, and finally freeing up your time to focus on running your business while hiring someone (for free) to be on your team (who is a professional in the office leasing process). It’s no surprise that the office leasing process is complicated, full of potential landmines, and heavily favors the landlord. I hope this helped to explain the most significant mistakes tenants make when renewing their office leases, so you do not make them next time!

Please do not hesitate to reach out to me if you have any further questions. My email is gcohen@cresa.com

Leave a Reply

Your email address will not be published. Required fields are marked *