Formulating a Renewal Strategy
“Tenants that congratulate themselves for renewing their lease simply to avoid the cost of relocation should put an ear to the wall and find out that the landlord is celebrating, too!”
Lease renewals are not as simple as they may appear and formulating an effective renewal strategy is a key component of the overall leasing process.
One of the first steps is to create a financial model evaluating the costs and risks associated with vacating your space at the end of the lease term. This analysis should take into account current fair market rents, absorption trends, lost income, tenant improvements, base building upgrades, and credit risk. A comprehensive financial model that compares the “apples to apples” costs of renewal versus relocation to be utilized throughout the process is critical. This analysis will increase your leverage with the building’s ownership during the renewal negotiations.
More than just Cost
The decision to renew or relocate should not be made solely on per‑square‑foot rental costs, but should also include the evaluation of various “remain in place” issues such as:
- Determining the difference in required space needs at the current facility vs. properties that are viable relocation candidates;
- The ability to upgrade the existing space for technological improvements, and the capital required to do so;
- The disruption to your business during any renovation or upgrades to the space;
- The ability to reshape the image or culture of the tenant, if desired; and
- Landlord issues such as signing the same lease, relying on a perceived tenant/landlord “relationship” to get a good renewal rate, and allowing the landlord to dictate the negotiation timetable.
Landlords inherently believe they operate from a position of strength in a renewal negotiation, due to better market knowledge than the tenant, control of the process and timetable, and an appreciation of the tenant’s “inertia” and the real cost of moving. However, with a professional tenant representative involved, the building ownership will understand the tenant is serious about pursuing relocation and will be aware of all relocation opportunities as well as associated rental rates for a renewal.
Credible Market Search
A critical part of any successful renewal strategy includes a credible search of the market, showing the landlord that you are serious about looking into alternative locations in order to reduce your occupancy costs. Competition for your tenancy is the great equalizer. The fact that market conditions have shifted to a more-tenant friendly environment as a result of recent economic conditions just increases the effectiveness of a credible market search.
Key Elements for Renewal Negotiations
For the tenant the ability to maximize the economic benefit, which it achieves if it renews, will hinge on the ability to shift the “market or valuation risk” from itself to the landlord. Although the renewal strategy will have to be tailored based upon the building’s situation as well as internal objectives, there are four key elements which are required to develop and implement a successful renewal strategy:
- Lease Provisions – the tenant must have a clear understanding of its lease provisions and utilize favorable clauses to its benefit and prepare defenses against potentially harmful provisions.
- Understanding the Landlord’s Objectives/constraints – implementation of an effective strategy will hinge upon the tenants ability to understand the issues and implications of the building’s current situation, including ownership profile and their financial objectives, building debt, tenant profile including credit, rate, and rollover, and the market perspective.
- Timing – the tenant must develop its occupancy strategy early enough to allow for a renewal to be developed outside of the renewal rights in the lease. The potential exists to negotiate terms and conditions tailored to the tenant’s needs while providing certainty to all parties.
- Well-defined Tenant Objectives – the tenant must clearly define its renewal goals in terms of rent, escalations, work contribution, subsidized services for employees, options and other lease rights.
- The Tenant’s ability to define a specific “target” prior to approaching the landlord will increase the tenant’s credibility with the landlord and ultimately your likelihood of success.
The Bigger Picture
A renewal strategy represents only one component of a more disciplined overall process methodology. Ultimately you want to make the best financial and operational decision for your company. Working with a quality real estate service provider who specializes in tenant representation will greatly increase the probability that you:
- Identify all viable occupancy solutions in the market and the cost associated with each alternative;
- Maximizing your negotiation leverage with the context of the market; and
- Structure a transaction that mitigates risk, minimizes occupancy costs and is align with your overall real estate strategy.
“We do not want to move and prefer to renew our office lease”
I have heard this many times from clients and companies I have visited with over my twenty year career. That objective is understandable and often proves to be the right decision. However, renewing your office lease should implemented with an effective strategy and proven approach.