How to Gain the Upper Hand When Renewing Your Lease

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In commercial leasing, renewal options are for the sole benefit of the tenant. They give the tenant the option to renew the lease of their existing space upon certain terms and conditions. From another perspective, they prevent the landlord from essentially kicking the tenant out at the expiration of the lease term and lease the space to another tenant. Typical terms and conditions that govern renewal options are the timeframe in which a tenant must notify the landlord of their election to exercise their renewal option and how the rental rate will be calculated for the renewal term.

Basically, tenants want the shortest timeframe possible and landlords want a longer (reasonable) timeframe. Shorter notification periods put landlords at a disadvantage because if a tenant chooses not to exercise its option the landlord must put the space back on the market. If the typical lease up time for a particular property type is 6 months and a tenant does not have to give notice until 3 months before the lease expires, the landlord could be looking at 3 months of vacancy and lost rental income. Generally, the longest timeframe is one year because neither party wants to risk changes in the market that might adversely affect the terms of the deal.

*I recommend 9 months. It gives the tenant the time to find another space, negotiate the deal, and build out the space within a comfortable but not excessive period. For landlords it allows them adequate time to market the space and thus minimize any vacancy periods.

The next, and perhaps most important detail, to negotiate is how the rent for the renewal period will be calculated. Landlords’ preferred language is “the greater of the then escalated rate or the then market rate” while tenants’ preferred language is just the opposite: “the lesser of the then escalated rate or then then market rate.” The compromise is thus typically “the then market rate.” This is often and rightly conditioned by such terminology as “for lease renewals, for similar tenants, and for comparable properties in the submarket in which the property is located.” Landlords will also try and add language that precludes free rent or improvement allowances from the negotiations. While tenants should certainly attempt to strike language such as this it is ultimately not as important as one may think. What is most important is “the then market rate” because market rates are influenced by other economic concessions such as free rent and improvement allowances (a good broker knows this and understands how to structure deals based on the net value of the lease).

Determinations of “market rate” can be quite different especially when two interested parties are involved. Would it surprise you to learn that tenants will typically have a lower estimation of the market rate than the landlord? In order to preemptively deal with a situation in which the tenant and landlord cannot agree on the “market rate,” it’s recommended to include a three-broker arbitration method as part of the renewal option. Without going into too much detail, basically the landlord’s broker provides their determination of market as does the tenant’s broker, they then agree to have an independent third party/broker review both and come up with their own determination of the market rate which is binding on both parties.

With all that out of the way, both parties must negotiate the best deal for themselves. Some people believe that there are certain tactics to use in negotiations that will yield the best results. That’s true to some extent but at the end of the day the real way to gain leverage in a negotiation is to have options. Telling the other side that you’ll walk away if they don’t agree to x, y, and z only works if you have another option. There’s nothing better to convince a landlord to agree to your terms than to show them the terms being offered by their competitor. The key to successful negotiations is leverage and the key to leverage is options.

The landlord knows that moving is costly and disruptive to a tenant’s business, employees, and/or customers. It’s not difficult to estimate these costs and if the landlord can negotiate terms that are equal to or lower than these costs for the tenant it makes sense for the tenant to renew in place. The landlord starts with this leverage. Tenants on the other hand know that landlords incur the risk of lost revenue from the space remaining vacant and capital expenditures for any improvement allowances, brokerage commissions, etc. in securing a new tenant. That’s their leverage.

How does a tenant then increase their leverage to incentivize the landlord to add another month of free rent or knock another $0.50 per square foot off the rate? They research and pursue other available options in the market and let the landlord know that they’re out in the market. Landlords are now no longer negotiating with the tenant, they’re having to negotiate with their competitors. There’s no better proof to support your assertion of “market” than to show what other landlords are willing to offer.

This presents an interesting dynamic. The tenant is most likely being offered more aggressive terms because the landlords offering them are competing to secure that tenant and there are higher costs to secure a new tenant than to keep an existing one. The current landlord knows this and can afford to lower the rental rate to be more competitive while saving the costs of large capital outlays such as tenant improvement allowances to customize the space for a new tenant. They just need to be forced to make the “right decision.” Their job to is to negotiate the best deal for them, not the tenant, and they will up until the point that they risk losing the tenant to another building.

For more information on this or representation services, please contact Ryan Rauner, CCIM at 703-943-7079 or Ryan@RealMarkets.com

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