Look at your lease: High vacancy rates make this a good time to negotiate or even move

moving sketchDo you want to save money on your commercial real estate lease? Now is the time to negotiate a better deal, say real estate watchers.

Despite the gradually improving economy, there’s still too much commercial space begging for tenants. That means your landlord may need you more than you need your landlord. And that can translate into lower rents or other good deals, such as a renovation of your space.

The nationwide vacancy for industrial space has climbed to 10.4% in recent months, says Robert Bach, chief economist at Grubb & Ellis, a commercial real estate services company based in Santa Ana, Calif. That level is the highest since the second quarter of 2004 and far above the sector’s 8% “equilibrium rate”—the rate at which rents typically increase by no more than inflation.

For office space, the vacancy rate has been running at 17.8%, the highest since the first quarter of 2005 and a hefty margin over that sector’s 12% equilibrium rate. As for retail space, vacancies have been averaging 11%, the highest level since the mid-1990s and considerably more than the sector’s 6% or 7% equilibrium rate.

Don’t wait to negotiate
If you’re looking to lower your real estate costs, the time to act is now. Most real estate observers say they don’t expect vacancy rates to go much higher.

“Overall, vacancy rates for all commercial property types have peaked and are slowly trending downward,” according to a new 2011 forecast from Grubb & Ellis.

“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.”

Other observers 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 in Salt Lake City. “We expect to see a slow and steady decrease in vacancy rates through the end of the year.”

The economic rebound has given landlords more of a psychological edge. And 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, some landlords have become more restrained when it comes to 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,” says Andy Fried, director of the Small Business Development Center at the Coles College of Business at Kennesaw State University in Kennesaw, Georgia. “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.”

All that said, the market remains favorable for negotiations. What steps can you take to capitalize?

For starters, dust off your lease and take a fresh look at the numbers, even if your renewal date is some time down the road.

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: Ask for free rent for a certain number of months.

“Landlords don’t like to reduce rent,” Fried says. “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.

Prepare yourself
Knowing your market is key to successful lease renegotiations. Do your research. You’ll want to answer two questions: What rents are others paying? What space is available for you to move to?

Here’s where the right help can make all the difference.

“The No. 1 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.”

More tips & tactics
What are the best techniques for negotiating a better deal?

“The most important factor is strength of the tenant,” says Mike Parkinson, a director at Retail Focus, a global consulting firm. “A national or international tenant will have a much better negotiating position.”

If you’re a tenant in a secondary market, making a threat to vacate at lease-renewal time frequently works.

“You might also consider taking a lengthy lease term, say a minimum of five years with renewals,” Parkinson says. “Giving the landlord some certainty may encourage amenability to deals.”

Here are some other tactics to consider:

  • Find an alternative location. Have a fallback space you could move into if your landlord balks at the new deal you propose. You can say something like this: “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” deal. If you have two years left on a five-year lease, try getting some immediate relief—in terms of free months of rent or a lower monthly rate—in exchange for signing a new five-year lease. (Only do this if you feel confident in your ability to fulfill a long-term contract.)
  • Watch your annual rent increases. An annual rise of 3% seems to be the industry standard for rent increases around the country. A landlord might ask for a 4% increase in exchange for funding some improvements to your space.
  • Negotiate rent escalations. If you sign a three-year lease that comes with an annual rent increase, prolong when it takes effect. Maybe delay the rent escalation for two years and put a cap on it. Beware of a lease that describes increases as based 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.
  • Secure termination powers. Try to get an agreement in which 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. One way to cushion your rental expense is to sublease part of your space to another business. This has to be negotiated upfront. Some leases prohibit the practice.

Chances of success
Your negotiating success will depend partly on the quality of the commercial property in the area in which 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.”

What about in less coveted areas? There, matters are different.

“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’ (renovate) space, a rent-free period or a combination of all of these.”

As the real estate observers suggest, it’s wise to 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.”

How a commercial real estate pro can help
Confused by your lease renewal options? Not sure about industry standards when it comes to commercial real estate?

You might benefit from hiring a consultant knowledgeable about commercial real estate in your area.

One good source is the membership list of the Counselors of Real Estate, which includes real estate, financial, legal and accounting firms that specialize in property lease negotiations. Check the website www.cre.org and click on “Find a CRE” to locate a counselor in your region. Another source of assistance is the International Tenant Representative Alliance at www.itraglobal.com.

Business tenants often turn to their brokers for advice at lease renewal time. That can be smart because landlords often will avoid proposing questionable terms if they know experts will be perusing the fine print. Just the fact that you have a broker will encourage your landlord to offer a better deal.

Remember that there are two types of brokers: tenant and landlord. The latter represents space marketed by property owners, so there can be a conflict of interest when it comes to lease terms. It’s smarter to use a tenant broker, who represents tenants exclusively.

Ask potential brokers for references then call them for feedback. Did the broker pursue better lease terms tenaciously? Bring in a lease that was “on budget” in terms of needs? Complete the work on time?

Related Posts

More from High Point Market

To see more High Point Market coverage in BedTimes,...

Carpenter website quiz rates sleep

Mattress industry supplier and consumer products producer Carpenter Co....

Campbell Mattress makes High Point debut

Family-owned Campbell Mattress, based in Cape Girardeau, Mo., made...