The 5 Steps To Successfully Negotiating a Commercial Lease
Commercial leases often incite feelings of fear and trepidation in tenants, especially those unfamiliar with the process. The legalese contained in commercial leases can often be confusing, making it a struggle to get through even one clause without some sort of headache; considering some leases can run as long as 40 pages and contain hundreds of clauses, it’s easy to see why tenants maintain a healthy fear.
Fear not! While commercial leases may seem intimidating, they all are representing essentially the same thing. That’s why it’s essential to have someone familiar with the process on your side during negotiations. A competent commercial real estate agent knows which clauses need to stay, which can go, and which are there because the landlord doesn’t think the tenant is paying attention!
Even with the best representation on your side, commercial leases can still seem daunting, but they’re actually constructed using a very simple formula at the heart of every lease. We broke down the commercial lease process into its component parts and came up with five steps for tenants to follow that will make the process easier to understand, less intimidating, and we hope even fun!
Step 1: Define Your Needs and Keep It Simple
Do you know the number one reason why commercial lease negotiations become complicated? It’s not lengthy leases or overly complicated legalese—the culprit is that expectations are not properly managed. That’s right, expecting one thing and receiving another—no matter how reasonable that alternative option is—is the main cause of contentious negotiations when it comes to commercial leases.
To avoid setting unrealistic expectations (which will only result in disappointment and resentment later), define your needs from the outset. Include every possible aspect you can think of, such as:
location;
timing;
moving costs;
cost of new furniture;
and rental budget.
The above are must-haves for any commercial lease negotiation, but you’ll want to add your own costs and considerations specific to your situation.
Once you’ve established your needs, enlist the services of a reliable and competent commercial real estate agent (like the friendly folks at MCRE!) and review your list with him or her. Your commercial real estate agent will be able to tell you which are reasonable and which are simply “nice-to-haves” to guide your negotiations and properly manage expectations.
When it comes to commercial lease negotiations, there will always be issues and hold-ups. An issue that should take two months to address can easily stretch out to four or six months if the tenant doesn’t have reasonable expectations entering into negotiations. Hold-ups can not only destroy good faith but also can substantially add to the cost of the process if there are significant delays.
If you establish your list of expectations and have it reviewed by a professional commercial real estate agent, you are in a much better position to negotiate as you understand what is worth fighting for and what can be bargained off.
Step 2: Consider Your Negotiating Power
When it comes to commercial lease negotiations, many consider the tenant to be at a disadvantage, but in actuality, the power dynamics of the negotiation are entirely dependent on the situation. It really comes down to who needs it most—a desperate landlord can likely be out-negotiated by a tenant with options, while conversely if a tenant desperately needs a certain space, the landlord holds the cards. Understanding your value as a tenant to your potential future landlord is key to developing an effective negotiating strategy.
A competent commercial real estate agent will be familiar with your landlord, or similar landlords, and be able to guide you through the most effective negotiations considering your position of power. For example, a tenant negotiating 1,000 sq. ft. of space in a 250,000 sq. ft. complex is unlikely to have much leverage; however, consider this: what if the complex is 80% vacant? In that case, a small landlord whose entire portfolio consists of that complex will probably be quite happy to negotiate, but if the landlord happens to be a REIT or other institutional fund, they probably have many buildings in their portfolio and are not too concerned with vacancy at one.
As you can see, your negotiating power is never a clear-cut answer, it always involves some element of analysis based on individual circumstances.
Step 3: Know Your Landlord
We touched on this briefly in point two but this is such an important element it deserves a step all on its own.
In commercial leasing, you will encounter all kinds of different landlords from giant investment funds to a sole owner simply looking to invest savings. Not only are these landlords different in their composition, but also are very different in terms of motivations and investment goals. Tenants unfamiliar with what motivates an institutional landlord can become frustrated very easily as negotiations progress.
The following is a brief overview of two basic divisions of landlords—large and small—and generally truths for these two groups. To truly understand the motivations of your potential future landlord, we recommend enlisting the services of a competent commercial real estate agent.
Large Landlords
Large or institutional landlords are typically banks, insurance companies, REITs or pension funds. An important fact to know about these investors is that they lease buildings based on predefined financial criteria (e.g. return on cash, return on the acquisition, lease-up, sales) and generally are not open to negotiation if the lease you are trying to negotiate doesn’t meet those criteria—you could be the best tenant in the world with the most reasonable demands, but when it comes to institutional landlords, it’s all in the numbers.
These landlords have deep pockets and are not easily influenced by high vacancy rates; generally, they will have sufficient cash flow to keep buildings vacant for as long as it takes to find tenants that meet the financial criteria.
Small Landlords
If large landlords are banks, insurance companies, REITs, and pension funds, then small landlords are everybody else. Small landlords can be a single person or a group but have typically paid for the building with their own money and often, that one building is their sole commercial investment property. While small landlords will have predefined financial criteria as well, they are much more incentivized to deal as it is to their advantage to have space filled rather than sitting vacant. Unlike large landlords, small landlords often lack the deep pockets to float a property until the ideal tenant is found—a tenant that is ‘good enough’ will often trump empty space.
However, simply because a landlord is small does not necessarily mean that they will be willing to concede power in a negotiation. It depends entirely on the situation and market forces at play. We recommend enlisting the services of a professional commercial real estate agent before entering into commercial lease negotiations.
Step 4: Separate Your Must-Haves From Nice-to-Haves
In any effective negotiation strategy you must always be willing to let go of something; however, deciding what you can live without and what you can’t isn’t as easy as it seems. Many inexperienced tenants are left disappointed after receiving their offer back from the landlord and discovering how little the landlord has conceded.
A commercial real estate agent will be able to review your “wish list” and provide guidance as to which items you are likely win, which are worth fighting for, and which are a lost cause. Setting reasonable expectations before submitted an offer ensures you aren’t caught off guard when your must-haves get the red pen treatment from your landlord.
By articulating which items are must-haves and which are nice-to-haves, you give yourself a blueprint of which items to negotiate hard for and which to concede.
Step 5: Enjoy Yourself!
Enjoying yourself may seem like an odd requirement for a commercial lease negotiation, but in our experience, mindset is everything!
Tenants who venture into the process unprepared generally feel stressed throughout and unhappy with the final deal. Conversely, those with a solid plan and reasonable expectations see the process for what it is—a new opportunity for your business! A new space can bring all kinds of great benefits from saving money to attracting a better calibre of employee. If you are well-prepared and know what to expect, the process can be quite enjoyable. You are negotiating a better future for your company, your employees, and for you!
With the advantage of knowledge and a competent commercial real estate agent on your side, the daunting process of negotiating a 40-page commercial lease can become an exciting challenge you will thoroughly enjoy. Remember, expectations are everything; if you know what to expect going in, you’ll be that much happier with the results in the end.