How to Negotiate a Better Lease

If there's any silver lining to our dark economic cloud, it has to be the attractive leasing deals many business tenants are enjoying.

For the first time in many years, tenants are in demand. No one likes to see companies shutter their doors, but the fact remains that for every business that closes some more space comes onto the market.

"Thanks to the current vacancy rates tenants are seeing the biggest selection of space and the most accommodating landlords since the early 1990s," says Robert Bach, chief economist at Grubb & Ellis, a commercial real estate services and investment company based in Santa Ana, Calif. "Landlords are nervous so tenants can get better deals."

All sectors of business are benefiting. In recent months, the nationwide vacancy for retail space has climbed to 9.5 percent, the highest level since the mid-1990s, reports Bach. That's considerably more than the sector's 6 or 7 percent "equilibrium rate" — the rate at which rents increase by no more than inflation.

The vacancy rate for office space has been running at 15.6 percent — the highest since the first quarter of 2005 and a hefty margin over that sector's 12 percent equilibrium rate. About 9.5 percent of industrial space is unoccupied, the highest since the second quarter of 2004 and much more than the sector's 8 percent equilibrium rate.

For anyone grappling with a tough selling climate, all that empty space translates into a stronger negotiating position come lease renewal time. "It is a tenant market right now," says Sharon Kahan, first vice president of CB Richard Ellis, a Chicago-based retail specialty brokerage. "If you are a tenant, you are in a good position. There's quite a lot of space on the market and probably more still coming."

Negotiate Rates

So what steps can you take to capitalize on the favorable market? For starters, dust off your lease and take a fresh look at the numbers, even if the renewal date is still some time down the road.

"Business owners should be seeking relief right now from their landlords," says Andy Fried, director of the Small Business Development Center, Coles College of Business, Kennesaw State University. "If the market is a whole lot lower than what's being paid on a given lease, negotiations should be initiated."

Maybe your first thought is a simple reduction in the monthly rental rate. And while that's not out of the question, another tactic is more likely to bear fruit with the same bottom line results: Free rent for a determined number of months.

"Landlords don't like to reduce rent," explains Fried. "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.

Many tenants are now routinely asking landlords for free rent as well as reductions. "This trend is new," says Bach. "I have never heard of this happening before at such a wide scale."

So how many free months can you get? "It varies by area," says Bach. "The tenant must check around the market to see what deals are being offered." Bach has heard of some tenants receiving six months free rent.

Do Your Homework

The phrase "check around the market" holds the key to your success in a lease renegotiation. "You have to do your research and line up your ammunition," says Kahan. You will want to answer two questions: What rents are others paying? And what space is available for you to move to?

With the answers to those questions in hand you can approach your landlord with a little more power. And one more thing: Show your own numbers. More landlords are having to take into account what a tenant can afford to pay. "Be prepared to show your sales figures," says Kahan. "Landlords will ask how much you are doing."

There's more, says Kahan: Have a strategic plan: "Landlords will also ask 'what will you do differently?' Show how you can do a better marketing job with the money you save with the rent. It's all about planning. Things don't happen on their own. You have to work hard and do your homework."

Win a Better Deal

As you pursue your own lease renegotiation keep these tips in mind:

Favor shorter terms Don't get roped in for a long period of time. Instead of a five-year lease try to get a two-year lease with the option to renew for successive two-year terms. That will save you from a big bill if you go out of business and are responsible for the remaining months of a long lease.

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.

Consider a "blend and extend" If you have two years left of a five-year lease, try getting some immediate rent relief — in terms of free months of rent or a lower monthly rate — in exchange for signing a new five-year lease, provided you feel assured of your ability to fulfill a long-term contract.

Find an alternative location Get a better seat at the negotiating table by having a fallback space if your landlord balks at a deal.

Obtain termination powers Try to get an agreement where 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.

Watch your annual increases An annual rise of 3 percent seems to be the industry standard around the country. A landlord might ask for a 4 percent increase in exchange for funding some improvements in your space.

Don't rely on oral statements Do things in writing by certified mail and keep copies of everything. Do not rely on what someone tells you. If the landlord says "Don't worry about rent this month," say "I want something in writing for my records."

Beware of personal guarantees Try to avoid personally guaranteeing the payments on your lease. A landlord can go after your own assets if your business fails.

A struggling tenant who sincerely wants to pay can look attractive in this market. Landlords are falling on hard times, too. And no one wants to pursue a lawsuit against a vanished tenant: Landlords have very little to gain by going after a tenant who is unable to pay. Lawsuits are expensive, and collections after a favorable verdict are difficult.

So how urgent is the need to take advantage of the market? Seize the day but don't expect a quick sunset. "Given the expected slow pace of the economic turnaround, good deals are going to be with us for awhile," says Bach. "They should be around through the first half of next year."

Getting Some Help

Negotiating a lease can be confusing, especially if you are not up to date on the jargon characteristic of the real estate industry. That's why business tenants often turn to their brokers for advice come lease renewal time. And that can be smart, since landlords will often avoid proposing questionable terms when 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.

Prior to deciding on a broker, though, ask for references in terms of current clients. Then get feedback from the references. Did the broker pursue better lease terms tenaciously? Bring in a lease that was "on budget" in terms of your current needs? Complete the work on time? And how well has the broker's lease withstood slow erosion by operating expense pass throughs?

Be aware 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 represent tenants exclusively.