Who Has the Upper Hand in a Lease Renewal?
Your small business lease is probably the second largest expense after paying your employees. For many small business owners, it is the largest expense. When looking to lease space to start your business, there can be many concessions and negotiations. Things like leasehold improvements, assigned parking, signage, etc. come into the give and take process. But frequently, when the fifth year, end of the lease approaches, the tenant suddenly thinks that the opportunity to improve the economics of the lease terms is impossible.
No one likes the prospect of relocating a business. It can cause frustration, unexpected expenses, downtime, or even worse, loss of employees. In the end, it might be more expensive in the short term or less expensive over another 5 years to relocate. Moving for marginal savings of 2% might not be worth the frustration but if you can save over 5% then relocating might prove more cost efficient over a five year period.
Lease renewal negotiations are time consuming and distract business owners from the core of their business. Many times the leasee will just sign the renewal without looking at it or negotiating with the owner. Who has the time to learn about true market conditions? Who has the time to learn the factors the landlord is considering? Who has time to negotiate?
Does the landlord necessarily have the upper hand? Here are some things that your rental company is looking at and that will probably give them leverage against you:
Statistics: At least 70% of all tenants extend or renew their leases. The landlord knows that you are thinking about the hardships of relocating.
Lack of planning: Planning is crucial. If you wait too long to start negotiating you might have no choice but to renew. Waiting too long to look at relocation alternatives puts the landlord on the five yard line with 4 downs to score. A typical 10,000 sq. ft. tenant needs at least 15 months before lease renewal or termination notification to visit other properties, negotiate a new lease, obtain city permits, build out the new location, and move the business. Less than this will severely impact any renewal leverage a tenant might have.
Benevolent dictatorship: Many tenants want to preserve a “good relationship” with their landlord. They would not think of telling them that they are considering relocation. The unfortunate effect of such a strategy is that it reinforces ownership’s belief that you have no options and don’t take the prospect of lease negotiations seriously. It’s a clear sign that you are prepared to settle for whatever is offered.
Knowledge: Landlords and building owners know the real estate market and what other sites cost to rent. They know commercial real estate development plans in the community. The landlord keeps up with the commercial real estate market weekly if not daily. Conversely, most tenants start to do their research every five years. It’s not their business.
Bluffing: The tenant does not know the demand for his space. The landlord always has someone else right behind the current tenant who will rent his space.
Relocation: Relocation can be very costly and time consuming. The landlord knows this. Fear will be a big motivator for the landlord to gauge the willingness of a tenant to renew.
You can bet that as a renewing tenant your landlord will offer you less than a new tenant. The landlord assumes that you are not shopping around. Handling a lease renewal should be treated like any other business operation — the management team makes a reasoned assessment of all relevant options and selects the best fit. It’s important to let ownership know that this is your approach to whatever terms they might offer — or expect you to accept in a lease renewal.
There are costs for relocating your business. Yet the landlord, too, will incur substantial costs if you leave for more favorable terms elsewhere. Here are some expenses that your landlord could incur: potentially lost revenue, promotional costs, brokerage commissions, infrastructure refurbishment, demolition costs and build-out costs. In every situation, these costs can be quantified with a high degree of accuracy, and should be part of discussions with the landlord to maximize the value you get as a renewing tenant. The differential in these costs — what a landlord will spend to attract a new tenant, and what they will spend to retain you — can be substantial, and easily exceed a year’s rent.
When landlords understand that lease renewals are not a “sure thing”; when tenants regularly subject lease renewals to an objective, market-driven process, the result is likely to be reduce occupancy costs across the board.
One way you can help your company reduce occupancy costs when renewing a lease or thinking about relocation is to hire a Commercial Tenant Representative. By engaging a Tenant Representative, your landlord is put on notice that you are aware of current market conditions, may consider relocation, and will insist on fair-market renewal terms. As with incurring any expense, analyze the cost-benefit before you sign an agreement.