Lease Flexibility – If we have learned anything over the last fourteen months, it is that global economic conditions can change rapidly. The companies that will thrive moving forward are those that are nimble and can rapidly respond to those changing conditions. We are just now emerging from the work from home experiment, and it is still too soon to tell how this phenomenon will impact the office market.
Despite this continuing uncertainty, it appears that more companies than not will return to the office. With rental expense typically the second largest item in any companies’ budget, it is imperative to negotiate as much flexibility into your commercial real estate lease as possible. Tenants will need the ability to expand and contract over time. The longer the term of the lease, the more flexible it will need to be. The following provisions can all contribute to increased flexibility.
One important factor to consider is the company’s projected growth. A startup company that expects to grow rapidly may not want to sign a long-term lease whereas an established company may be fine with a longer-term lease.
Another important issue to consider is the prevailing economic climate when the lease is signed. When economic conditions are strong, the cost of real estate is at the high end of the cycle. Signing a long-term lease in a strong climate could lock you into a high rent lease for years to come. In a strong economy, it may be better to sign a shorter lease. Conversely, during a recession lease costs are at the low end of the cycle. This is typically a good time to sign a long-term lease. In the current climate, office leasing has been slow and vacancies have increased. Most landlords are offering generous concessions. For many tenants, it is currently a good time to sign a long-term commercial real estate lease in order to lock in favorable terms. Tenants with several years left on their lease may want to extend their lease in consideration for concessions that may not be offered several years from now.
Lease Termination and Contraction Options.
A lease termination or contraction option can be an excellent way to achieve lease flexibility. Landlords are not fond of these provisions, and they can be difficult to obtain. Most landlords will not even consider termination or contraction for a lease term less than seven years. In addition, these options are not free. At a minimum, the landlord will require payment of unamortized costs associated with tenant improvements, brokerage fees, and rent concessions. While not free, termination and contraction options offer significant flexibility.
As a company grows it may discover that it needs more space. Rather than facing the prospect of a move and then having to sublet existing space, a company may be able to build a series of expansion options into its lease. A right of the first offer will provide a “first look” at any space that opens up in the building. A right of first refusal requires the landlord to give the tenant the opportunity to rent a particular space in the building before offering it to a third party. Companies that expect rapid growth should stick with larger multi-tenant properties as those types of properties offer more flexibility for expansion.
A renewal option gives a tenant the legal right to extend a lease after the initial term has ended. The terms of the renewal are outlined in the lease. Renewal clauses define how far ahead of time it is necessary for the tenant to inform the landlord that it wishes to renew. Try to negotiate at least a 12-month notice period in order to have time to consider other options. Many renewals provide that they will be renewed at “fair market value”. The term fair market value must be defined. The goal is to have an objective third-party means of determining fair market value. Also, it is important that the fair market value takes into account the tenant improvement allowance and concessions the landlord would have to offer a new tenant.
Assignment and Subletting.
Circumstances may arise in which it is necessary for a tenant to vacate their space early. In such instances, an assignment or sublease is a very beneficial provision to have. An assignment differs from a sublease in that an assignment transfers the original tenant’s rights and obligations under the original lease to a new tenant. The original tenant is completely off the hook.
With a sublease, the original tenant remains liable for lease payments in the event the subtenant defaults. Landlords prefer subleases because then they have two tenants liable for rent. The landlord will typically only grant automatic assignment rights to affiliates or successors of the original tenant. With either sublet or an assignment, the Landlord will want the right to approve the creditworthiness of the subtenant or assignee and the terms of the sublet or assignment. It is very important to negotiate that the landlord’s consent will not be unreasonably withheld.
If possible, avoid any requirement that the tenant offers the space first to the landlord. This is known as a “recapture provision”. If the landlord does have the right to recapture, try and limit the time frame for recapture. Also, try to negotiate the right to offer the space to other tenants in the building. Finally, it is crucial that the tenant have the ability to sublease its space for less rent than that being offered by the landlord.
With some careful advance planning, it is possible to negotiate a commercial real estate lease that takes into account projected future space needs while at the same time providing for maximum flexibility in terms of contraction and expansion. Each tenant’s ability to successfully negotiate the most tenant-friendly terms will depend in part on the creditworthiness of the tenant, the amount of space leased, the cost of tenant improvements, and the term of the lease. Tenants with great credit who take larger suites for longer periods of time with a small tenant improvement budget will obtain the best terms.
At Mobiliti CRE we focus 100% on representing tenants with site selection, office relocations, expansions, contractions, and subleases throughout Tampa Bay and the entire West Coast of Florida. We also assist businesses that are looking to purchase office, medical office, industrial, and retail space. Reach out to us for assistance with all of your commercial real estate needs at (813)-300-2227 or email us at email@example.com
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