Phillip M. Perry (March 2011)
Looking to save money on your lease? Now is a good time to negotiate a better deal.
Despite the improving economy, there's still too much space begging for tenants. That means your landlord may need you more than you need your landlord. And that can translate into lower rents.
The nationwide vacancy rate for industrial space has climbed to 10.4 percent in recent months, according to Robert Bach, chief economist at Grubb & Ellis. That is the highest level since the second quarter of 2004, and significantly more than the sector's 8 percent equilibrium rate (the rate at which rents increase by no more than inflation).
For office space, the vacancy rate has held at 17.8 percent, the highest since the first quarter of 2005 and a hefty margin over that sector's 12 percent equilibrium rate. As for retail space, vacancies have been running at 11 percent, the highest level since the mid-1990s and considerably more than the sector's 6-7 percent equilibrium rate.
The time to strike is now. Most real estate observers say that the vacancy rate is roughly as high as it's going to get. In some markets, the trend has leveled off as business owners seek expansions.
"Overall vacancy rates for all commercial property types have peaked and are slowly trending downward," according to Grubb & Ellis' 2011 Forecast.
"The deals are still there for tenants, particularly as you move down the quality spectrum," Bach says. "But for the better properties - well located, strong trade areas, not a lot of competition - landlords can afford to be a little more choosy than they were six or 12 months ago."
Others agree. "While 2011 should continue to be a renter's market, we seem to be at a turning point," says Jeffrey Allen, director of operations at Trendant Consulting. "We expect to see a slow and steady decrease in vacancy rates through the end of the year."
So what steps can you take to capitalize on the favorable market? For starters, dust off your lease and take a fresh look at the numbers, even if your renewal date is still a ways off.
Your first thought might be to ask for a reduction in your monthly rental rate. While that's not out of the question, another tactic is more likely to bear fruit with the same bottom line results: free rent for a set number of months.
"Landlords don't like to reduce rent," says Andy Fried, director of the Small Business Development Center at Georgia's Coles College of Business. "Many landlords buy real estate for investment purposes, so they want to keep what they call the capitalization rate up. The higher the rent roll, the higher the value of the building." To maintain their investment, landlords will often opt to grant free rental months rather than cut the official rental rate.
Do Your Homework
Knowing your market is key to a successful lease renegotiation. Do your research and line up your ammunition. You will want two questions answered: What rents are others paying? And what space is available for you to move to?
Here's where the right help can make all the difference. "The number one factor for successful negotiating is having a great real estate agent," Allen says. "Go with the best commercial agent in your area. That person will know what's negotiable and what's not, and will already have a lot of connections with business owners and will know their issues. It all stems from that."
How do you find the best agent? "It becomes pretty obvious once you start looking around and talking with other business people," Allen says. "Call brokers and ask for the name of their top commercial real estate agents ranked by sales volume. Look at advertised listings and scout around for the `for lease' signs in your area. Whoever has the most signs is often the best agent."
What are the best techniques for negotiating a better deal? "The number one factor is strength of the tenant," says Mike Parkinson, a director at international consulting firm Retail Focus. "A national or international tenant will have a much better negotiating position."
If you are a tenant in a secondary market, a threat to vacate on renewal frequently works, Parkinson says. "You might also consider taking a lengthy lease term, say, a minimum of five years with renewals. Giving the landlord some certainty may encourage amenability to deals."
Here are some additional tactics:
• Find an alternative location. Get a better seat at the negotiating table by having a fallback space if your landlord balks at a deal. You can say something like, "Look, we have a new deal at a new location where those guys will pay for us to be there. Or we can do a deal with you at this new number."
• Consider a "blend and extend." If you have two years left of a five-year lease, try getting some immediate rent relief (free months of rent or a lower monthly rate) in exchange for signing a new five-year lease, provided you can fulfill a long-term contract.
• Watch your annual increases. An annual rise of 3 percent is the approximate national industry standard. A landlord might ask for a 4 percent increase in exchange for funding improvements to your space.
• Negotiate rent escalations. If you sign a three-year lease, it comes with an increase each year. Prolong when the increases take effect. Try to delay the rent escalation for two or three years and put a cap on it. If the lease bases the increase on fair market value, that may be higher than you expect if vacancies decline in your market.
• Obtain the right of first refusal. Make sure your lease includes a first right of refusal clause. This gives you the right to decline a renewal before the landlord offers the space to someone else.
• Obtain termination powers. Try to secure an agreement where either party can terminate the lease with 90 days notice. Landlords don't like it, but in this market it's easier to negotiate exit strategies.
• Obtain the right to sublease. Subleasing part of your space to another business cushions your rental exposure. However, this must be negotiated up front. Some leases prohibit the practice.
Your negotiating success will depend partly on the quality of the neighborhood where you operate. "Landlords are well aware of the value of the best AAA sites," Parkinson says. "While some of these landlords will offer incentives, these rents are not very negotiable."
Matters differ among sites. "Landlords in secondary areas, such as some neighborhood strip centers and central business districts, are susceptible to tenant negotiations," Parkinson says. "Possibilities may include a reduced rate for square footage, a cash contribution to fit-out [redesign] space or a rent-free period, or a combination of all of these."
The window for better deals is gradually closing. Given the rebound in the economy, Grubb & Ellis says vacancy rates have essentially bottomed out. Some markets are seeing a drop in vacancy rates.
The economic rebound has also given landlords a psychological edge. Landlords who are less nervous about the future than they were a year ago will be less prone to deal. "Any given set of market conditions looks different on the way up versus the way down," Bach says.
In recent months, landlords have become increasingly restrained towards lease modifications. They want to make sure that businesses are strong enough to thrive after the terms are changed. "More landlords are asking to see financial statements before lowering rent," Fried says. "They figure the tenant who is really broke is not worth retaining anyhow. So there is not as much room to maneuver as a year ago."
Have a strategic plan. Landlords will ask, "What will you do differently?" Show how you can do a better marketing job with the money you save with the rent.
Go into negotiations armed with data on your operations and on rental rates for properties near your location. "In all cases, a healthy discussion with your landlord will usually produce results," Parkinson says. "Remember that there can be no successful negotiation without compromise from both parties. The level of compromise is directly related to the amount of concession sought."