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Posted by David Klein, Esq., SIOR, LEED AP on Wednesday, August 24, 2011

On Handling Lease Renewals

During my 25 years advocating, defending and litigating on behalf of business clients, the worst mistakes I've seen were made during an economic up-cycle, when my clients are too busy making money to pay attention to managing costs. Inasmuch as real estate expenses take a big chunk out of the bottom line, I offer this advice when it comes to lease renewals:

Be prepared to negotiate before the lease comes up for renewal.

Presuming my client has entered into a lease with a renewal option, I recommend they put a tickler in their calendar to remind them to look at the office market well in advance of the renewal date. When that time comes, I suggest they reframe the renewal as a lease extension with an entirely new rental rate. This is especially important if their renewal option provides a floor rental rate that’s higher than market, but this gambit will usually save them money one way or the other.

This stratagem usually works even when a commercial tenant has an option to renew their lease at a "market rent." After all, most landlords will prefer to keep a good tenant in place rather than incur the downtime of lost rental income, costly tenant improvement expenditures and unnecessary leasing commissions required by replacing them. For instance, even in today's San Francisco’s relatively healthy office market, it takes more than a year to re-rent the average office space. In that light, a prudent landlord would be well-advised to accept a nominally lower rent than face the risk of vacancy.

Advice for Corporate Counsel

Here’s my advice to corporate counsel: First, advise your client to retain a commercial real estate broker qualified in the market and product type in client’s vicinity. The inquiry should be to the landlord what the rent would be if the option were exercised. Most landlords will gladly provide this information if asked. The broker should then survey the peer group of buildings in the submarket that are similar in type and age to the client’s building and determine whether the peer-group buildings have space available similar to your client’s. The broker should generate a written report of the rents and terms that could be achieved in space in the peer buildings if the client were to move there. What you will typically find is that a neighboring landlord with a vacant space is much more likely to quote a rent that is below the rent that the landlord has suggested would be the renewal rent for extending your client’s lease. It is also important to ask the broker is to find out what they can about what other tenants in the client’s building are doing. Will they be competing for your client’s space or moving out and causing more trouble for the landlord? This information may be helpful at the negotiating table.

Armed with documentary evidence and information, go back to your client’s landlord and suggest the terms quoted by the peer buildings. You should find that the incumbent landlord will be very amenable to reduce their quoted rate in order to maintain your client as a paying tenant in their building.

The option to renew should be a last resort to extend a lease rather than a reflexive decision. Negotiating a new rental rate for a term beyond the base term of a lease need not prejudice or bar the exercise of a contractual renewal option, and could the tenant a lot of money.

David Klein, Esq., SIOR, LEED AP, one of Opine Experts’ forensic real estate consultants, is a California real estate broker and attorney with 25 years’ experience as a commercial real estate practitioner.

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