Top 5 Most Common Mistakes Tenants Make When Renewing Their Lease
Let’s face it, none of us knows everything there is to know about any subject matter – even the experts. Life is a journey of learning. One of the beautiful things about life is that we don’t have to learn all of our lessons in the school of “hard knocks.” I love learning from other’s mistakes, so I don’t make the same blunder. In that same spirit, here is my gift to those of you with lease renewals in your future; the following are the top five mistakes tenants make when renewing their lease:
(Listed in no particular order of importance or frequency)
1. Starting the process too late
Time can be a tenant’s friend or their enemy when it comes to negotiations. With lease renewals, if the tenant waits too long to start the process of exploring alternatives in the market, their opportunity to create leverage will drastically diminish because the landlord knows it is highly unlikely that they will have enough time to move before expiration of the lease. This means that even if they do end up relocating, they either must pay hefty holdover fees or negotiate a short-term extension with a reluctant landlord that knows they are going to leave (i.e. good luck).
Some rules of thumb: The larger footprint a tenant has, the earlier the process should start (this could be 2-3 years or more before expiration in some cases); typically, a good tenant broker will approach the process as if the tenant is moving, even if this is not the goal. This means terms should be pretty much fully negotiated with the landlord and/or relocation alternatives at a minimum of 6-9 months before lease expiration; this gives time for lease negotiation, construction drawings, permitting, tenant improvement buildout, and move in. Starting the process early leaves room for unseen events and extended negotiations which are sometimes necessary to achieve the desired goals of the tenant.
Additional questions tenants should be evaluating, with the help of their tenant broker, is whether or not there are target market or submarket indications that demand for space is weakening, and if so – is there corresponding evidence that market concessions to tenants are increasing? Should the answer be ‘yes’ to one or both questions, then it is likely time to start the strategic planning and market engagement process.
2. Not engaging the market
Even if the tenant is knowledgeable about the market or real estate in general, or perhaps tangentially deals in the commercial real estate business as part of their enterprise (for example a law firm), negotiating in a vacuum is never a good idea.
Landlords understand that tenants renew 70% of the time on average. Landlords also understand that renewals are generally more profitable for them because there is typically not as much investment on their part, and there is no extended interruption of cash flow from rents (see number 4 below for more on renewal economics). For the tenant to receive a truly equitable deal (not just a “market deal”) and really understand their buying power, they must earnestly engage the market and let the landlord understand that they as a tenant understand their particular renewal economics and want a win-win deal if they are going to stay in the landlord’s building. The leverage created by this fear of loss for the landlord will bring them to the negotiations with the proper mindset to achieve an equitable deal for both parties.
“He who represents himself has a fool for a client.”
– Abraham Lincoln
3. Not using a tenant broker
Even an average tenant broker knows more about the market than the typical tenant and can add value to the process for the tenant that exceeds the broker’s commissions. Why do tenants not use brokers? There is probably a myriad of reasons, but the one I hear the most is the perceived cost; I say, “perceived cost” because the notion of saving money by not using a tenant broker is a fallacy.
Landlords underwrite into the rent rates all commissions to property managers and brokers, and they have no problem paying those fees because it actually increases the building’s long-term capitalized value—which is where the landlord’s profit is derived from — not year-to-year cash flow. If the tenant doesn’t use a broker, those fees or most of those fees don’t disappear and are still getting paid to internal and 3rd party entities and the tenant’s true savings is none or nominal compared to what they could have saved using a tenant broker.
Let’s step back and think about this soberly from a different perspective. Landlords are in the business of making money in real estate and they pay for representation in their renewal negotiations. Most tenants are not in the business of real estate.
Tenants need tenant representation more than landlords need representation on a renewal.
Even if the tenant has a good relationship with the landlord, the landlord’s fiduciary responsibility is to their partners and/or investors. It’s their business to be friendly and provide good customer service, but they won’t just give a tenant a true break in the renewal because they’re the tenant’s “friend” or “client.” Law firms and accounting firms are sometimes susceptible to this flawed line of thinking, and I believe some landlords employ this tactic to engender a sense of loyalty and potentially take the tenant broker out of the deal to get a more advantageous negotiating position over their tenant “friend” or client. This also could ensure the tenant won’t potentially discover that the incumbent building is not the best fit for tenant.
Real leverage will always help a tenant define true “market” – not the fact that the tenant may have negotiated some free rent or a small rent increase or rent reduction, while negotiating in a vacuum or relying on published market data to determine what is market.
4. Exercising a renewal right unnecessarily
Typical renewal right language in a lease calls for a renewal rate that is 95% of what is then “market rent” at the time of exercising the renewal option. Sounds great, right? Wrong! In short, as alluded to in mistake #2 above, landlord profits are greater in renewals because of reduced tenant improvement costs, less abated rent concessions, and most importantly – no vacancy. This means landlords have a lot more to lose, and the tenant can leverage that fact into a much more reasonable and equitable deal when properly negotiated by the tenant broker. For an excellent breakdown on typical renewal option economics and why they grossly underserve tenants, please refer to my Exis colleague’s (Tactix) blog.
“Things are not always as they seem; The first appearance deceives many….”
5. Not having the proper perspective
Too often, even in a tenant’s market, tenants may feel powerless in their specific real estate situation for any number of reasons. They may feel like a “captive” tenant without hope for a better lease or better space in which to conduct their business. In reality, 99% of the time there is hope for whatever situation that may seem insurmountable in the renewal scenario. Tenants have more power than they realize… even smaller tenants! For an in-depth look at the proper mindset during a renewal or relocation, visit my previous blog on the subject.
In summary, tenants can avoid all these common mistakes and more by partnering with a knowledgeable tenant rep broker from a firm that only works with the occupiers of space. Tenant rep brokers can guide them on timing, and how to strategically engage the market in their specific situation while representing them in, and advising on, the market in an unconflicted manner.