The Office Space Revival
Vacancies are down, rents are up. How can your company buck the trend and save money?
Paul Whitman, Executive Vice President, The Staubach Company and Karra Parker Guess, Chief Operating Officer for Southwest Client Services, The Staubach Group (April/May 06)
After a downslide in the early part of this decade, office rental rates are on their way up in many major markets nationwide. The nationwide average vacancy rate - 12.5 percent - has continued to decline, and rental rates have increased 2 percent since the end of 2004. For most companies, rent is a major expense, second only to personnel in the effect on the bottom line. But even in a tough market, smart executives can manage costs by using several proven strategies.
Anticipate the Market Revival
If your company is willing to extend its lease past the original expiration date, many landlords will renegotiate up to three years in advance. Not only does this allow you to restructure parts of your original lease that might need updating, but can act as a hedge against upcoming rate increases. This strategy is a winner for both sides - the landlord wins with a longer term, and your company wins with a better lease and a hedge against rate inflation.
The Staubach Company used this strategy very effectively in the rising markets of the late 1990s and early 2000s. We even built a proprietary model to show tenants and landlords the efficacy of going to the negotiating table early. By starting lease negotiations with three years left on the lease term, we saved a major law firm $5.8 million over 13 years. Even shorter term leases are a target for this strategy. A local oil company had three and one-half years remaining on its lease; we negotiated a four-year extension past the original term and saved the company $3.4 million over seven and one-half years.
If your company has multiple locations, make a list of those where your risk of real estate cost increases is greatest. Then have your real estate representative call your landlord when there are two to three years left on the lease term.
Know Your Landlord's Bottom Line
In major markets, most office buildings are owned by large, publicly traded real estate investment trusts (REITs), insurance companies, or pension funds. A quick check of your landlord's website or 10K and a few conversations with industry insiders will yield information about required rates of return, your building's occupancy, and your landlord's economic objectives. This knowledge will help your company in its negotiations. Some large institutional landlords even go public about their pricing and occupancy objectives in major buildings. REITs are particularly good about making disclosures of this nature.
Several years ago in Dallas, a major REIT publicly announced that it was lowering rental rates in various downtown buildings to increase occupancy. The REIT's representatives even explained what was driving the decision and how their profit targets were derived. We were able to use this information to save several clients significant real estate costs. In addition, we helped two nonprofit corporations find affordable space in one of the REIT's buildings, an assignment that is very difficult to fulfill in major markets.
Leverage the Competition
Find at least two comparable buildings that would be suitable for your company and negotiate with both simultaneously. Be open about your interest in both. Sometimes this strategy can result in savings of 10 percent or more off an original offer. These buildings do not have to be in the same submarket; often, forcing a downtown building to compete with one in the suburbs results in more savings. Be careful, though, to pick realistic possibilities for your company, because you may get an offer you can't refuse. Publicly traded corporations that turn down low-cost offers may get into hot water with their boards and their shareholders.
Rent Is Not the Only Issue
Remember, the rental rate is only one component of a lease transaction. Other economic factors such as remodeling allowances, operating expenses, parking, and even important legal provisions can add significant savings to a transaction. If an owner will not give your company the rate required, try to negotiate other savings in the form of increased construction allowances, a cap on operating expense increases, or reduced parking charges.
Take parking, for instance. In Dallas, parking costs typically add $2.75 per square foot per year to the overall lease costs. In New York, Chicago, San Francisco, and Los Angeles, these costs are even higher. So it's worth paying attention to line items other than rent.
Your Company's Renewal Option
In extremely tight markets, a renewal option can save your company from an expensive move or rapidly increasing rates. Most renewal options include rules to fix the renewal rental rate. Since a renewal option is binding, an owner must honor the provisions of the option even if a larger tenant is willing to sign on the dotted line at a higher rate. Our San Francisco office successfully used this strategy for Cisco's multiple leases during the technology boom of the late 1990s. Had Staubach not negotiated strong renewal options for Cisco in the first place, in many cases Cisco would have been asked to vacate in favor of the latest startup telecom company willing to pay exorbitant rates. For companies executing leases in new locations, a renewal option is absolutely essential.
Garbage In, Garbage Out
Good real estate data is imperative if your company has multiple locations. You would probably be surprised at how many large companies Staubach has represented that have not populated a real estate lease administration database. It's impossible to manage real estate requirements without a central database or file that contains accurate, pertinent information. The bottom line is this: If you don't have good data for your multiple locations, you cannot do a reasonable job of managing costs in a rising market.
We signed a national contract with a company with thousands of locations across the United States about three years ago. The company had a poorly populated database with inaccurate information and had recently missed the deadlines for several renewal options (resulting in more than $1 million in lost savings). We hired temporary paralegals to abstract every single lease and populate a new lease administration database. Within a year, we had saved the company in excess of $10 million in real estate costs.
Hire a Qualified Agent
Whether you choose to use The Staubach Company or another real estate company, hire someone qualified to negotiate your lease or purchase. A good agent may save you more than 10 percent and sometimes closer to 30 percent. Real estate agents have access to information your company cannot obtain without a real estate license. Also, an experienced agent has probably reviewed hundreds of contracts, possibly even thousands. Finally, agents know the ins and outs of negotiating with various owners and will be familiar with most of the techniques listed above.
Paul Whitman is executive vice president of The Staubach Company and a member of the Society of Industrial and Office Realtors. Karra Parker Guess is Staubach's chief operating officer for Southwest client services. Both work out of the company's Dallas headquarters.