Lease Renewals: The Last Option

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Page 1 Allegro Realty Advisors, visit us at www.allegrorealty.com Damon M. Taseff Principal Allegro Realty Advisors, Ltd. 216-524-0710 x112 [email protected] LEASE RENEWALS – The Last Option Why shouldn’t your company exercise its renewal option? The answer to this question is simple – because, in many cases, depending on market conditions, better deal terms may be available if you strike a new deal with your landlord. Unfortunately, renewals are often looked at as matter of fact, standard modus operandi, easy to deal with and move on. There are common themes behind the rationale used to justify exercising renewal options. Many times, the person responsible for real estate is too busy and doesn’t have the time to deal with the issue and properly focus on the renewal opportunity. Money is undoubtedly left on the table. Other times, the same individual will have no intention or interest in moving. By default, they exercise their renewal instead of opening up negotiations with the landlord. Money is undoubtedly left on the table. Worse yet, the individual will be hesitant due to concerns related to legal and real estate fees or even landlord relationships. Ultimately, they exercise the renewal option because they believe it will be, in the short term, a less expensive proposition. Again, money is undoubtedly left on the table. Whether you are managing a complex real estate portfolio or are responsible for the lease at a single location – having a renewal option is not reason enough to exercise it. The renewal option creates a “not to exceed” guarantee, a worst case option, from where you can work to negotiate and create a better set of terms for you and your organization. It guarantees you the right to your space at pre-determined terms, so the landlord cannot lease your space to another tenant and force you out. Even if the lease was properly negotiated, the renewal terms very easily could have been glossed over, resulting in landlord-friendly renewal terms. Rental rates are functions of debt, interest, equity, operating expenses plus any amortized improvements or commissions and profit. A landlord will always be willing to make cosmetic alterations such as installing new carpet and paint to accommodate a new tenant. Commissions will also need to be paid. This is at a minimum. In order to attract new long-term tenants, a landlord very often Kevin Yates Manager Allegro Realty Advisors, Ltd. 216-524-0710 x108 [email protected] Subscribe at www.allegrorealty.com to receive the latest real estate research, analysis, and news from Allegro Realty Advisors Whether you are managing a complex real estate portfolio or are responsible for the lease at a single location – having a renewal option is not reason enough to exercise it. 8111 Rockside Road, Suite 250 Cleveland, Ohio 44125 Phone: 216-524-0710 Fax: 216-524-0711

Transcript of Lease Renewals: The Last Option

Page 1: Lease Renewals: The Last Option

Page 1Allegro Realty Advisors, visit us at www.allegrorealty.com

Damon M. TaseffPrincipalAllegro Realty Advisors, Ltd.216-524-0710 [email protected]

LEASE RENEWALS – The Last Option

Why shouldn’t your company exercise its renewal option? The answer to this question is simple – because, in many cases, depending on market conditions, better deal terms may be available if you strike a new deal with your landlord.

Unfortunately, renewals are often looked at as matter of fact, standard modus operandi, easy to deal with and move on. There are common themes behind the rationale used to justify exercising renewal options. Many times, the person responsible for real estate is too busy and doesn’t have the time to deal with the issue and properly focus on the renewal opportunity. Money is undoubtedly left on the table. Other times, the same individual will have no intention or interest in moving. By default, they exercise their renewal instead of opening up negotiations with the landlord. Money is undoubtedly left on the table. Worse yet, the individual will be hesitant due to concerns related to legal and real estate fees or even landlord relationships. Ultimately, they exercise the renewal option because they believe it will be, in the short term, a less expensive proposition. Again, money is undoubtedly left on the table.

Whether you are managing a complex real estate portfolio or are responsible for the lease at a single location – having a renewal option is not reason enough to exercise it. The renewal option creates a “not to exceed” guarantee, a worst case option, from where you can work to negotiate and create a better set of terms for you and your organization. It guarantees you the right to your space at pre-determined terms, so the landlord cannot lease your space to another tenant and force you out. Even if the lease was properly negotiated, the renewal terms very easily could have been glossed over, resulting in landlord-friendly renewal terms.

Rental rates are functions of debt, interest, equity, operating expenses plus any amortized improvements or commissions and profit. A landlord will always be willing to make cosmetic alterations such as installing new carpet and paint to accommodate a new tenant. Commissions will also need to be paid. This is at a minimum. In order to attract new long-term tenants, a landlord very often

Kevin YatesManagerAllegro Realty Advisors, Ltd.216-524-0710 [email protected]

Subscribe at www.allegrorealty.com to receive the latest real estate research, analysis, and news from Allegro Realty Advisors

Whether you are managing a complex real estate portfolio

or are responsible for the lease at a single location – having a

renewal option is not reason enough to

exercise it.

8111 Rockside Road, Suite 250Cleveland, Ohio 44125Phone: 216-524-0710 Fax: 216-524-0711

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Page 2Allegro Realty Advisors, visit us at www.allegrorealty.com Allegro Realty Advisors, visit us at www.allegrorealty.com

has to make a much larger investment, including demolition and construction costs within the suite. These costs will be amortized and added to the rent. For example, if a landlord needs $20 per square foot to cover debt, interest, equity, operating expenses, an additional $20 per square foot would be amortized and added to cover the improvements. By the end of the lease, the landlord will have been reimbursed for the cost of all improvements.

In some cases, rent rates increase successively year over year based on a predetermined factor. This factor could be a fixed step percentage rate or tied to the consumer price index. The same can be said for renewal option rent rates. They are also typically based on successive year increases, and tend to build from the original rent rate. The table below shows a 5-year lease with a $25 rent rate that increases 3% year over year. The renewal period for years 6-10 follows the same trend, increasing 3% year over year.

As discussed above, the landlord amortized $20 per square foot during the original 5-year term to reimburse costs associated with commissions and tenant improvements. By the end of year 5, these costs were completely recovered. However, the rent schedule does not reflect this recovery. Instead of realizing relief in years 6-10, the tenant continues to pay an increased rent, as if there are comparable new improvements to be amortized over the renewal period. The table reflects the expiration of the amortized $20 per square foot and resulting corrected rent rate adjusted for 3% year over year inflation. The table shows very clearly how these renewal option rental rates can be deceiving.

When a landlord agrees to a renewal option, they lose flexibility and handcuff themselves in the future; an unknown future. Because of this, the rent rates associated with these renewal options rarely are in the best interest of the tenant. If the landlord is astute, rent rates will be in priced in excess of the expected market and many times will not reflect fair relief associated with the completion of fully amortized improvements within the original term, as discussed above. The inaction or lack of desire to capitalize on this inequity ultimately costs you money.

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It’s very easy to become complacent and renew according to the previously negotiated terms. In some cases, these terms may have been negotiated up to 10 or 15 years ago. It is always best to take the time and press the landlord for better terms than already granted in the renewal option. If the real estate requirement is managed correctly and dealt with well in advance of critical notice dates outlined in the lease, there will almost always be better results for the tenant.So think twice the next time your lease expiration is approaching. Don’t fall into the renewal option trap. Realize that it’s the quick and easy solution, but also that it will likely cost you and your organization money in the long run. Make the right decision for your company and take the money that’s sitting on the table.

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Allegro Realty Advisors, Ltd. is a commercial real estate services firm that serves corporations across the U.S. from our Cleveland, Ohio headquarters. We can help your organization whenever real estate requirements arise and you need deep industry and technical experience. For a better understanding of our commitment, service and experience with other clients like yourself, visit us online atwww.allegrorealty.com.