Bars and cocktail parties bring out the worst in market statistics. Everyone’s new car cost less than it actually did, and everyone’s new house is worth more than it actually is. But in our experience, the worst in cocktail party market statistics relate to deals on office space.
The best deal?
For the record, we have never heard anyone say that they got a lousy deal in leasing office space. The rent was always the lowest possible, or the free rent was abundant, or the fit out allowance excessive. But interestingly enough, no one ever talks about the non-economic terms of the lease that can really impact on a startup or rapidly growing company – expansion, contraction, termination, etc. This seems to get lost in the economics of the deal, which is a real shame.
Simply stated, the best deal is defined as “the deal that is the most advantageous to the parties.” However, for startup companies and companies experiencing rapid growth, the best deal should focus on one word – flexibility. Are the terms flexible enough so that the tenant occupant can grow in place, expand if necessary, contract if desirable, or even terminate the occupancy if necessary?
Flexibility in offices leasing
Historically speaking, the one word absent in leasing office space has been “flexibility.” After all, lease terms have to be precise as they relate to rent, improvement allowances, and length of the lease. There are mortgages to pay with specific terms to address. Investors have anticipated returns. Improvements have to be constructed pursuant to detailed architectural drawings. As a result, the last word used in such a situation was “flexibility.” Then the mobile tech revolution and millennial demographic tsunami hit. Leasing office space is changing accordingly.
The impact of tech on flexibility
Twenty years ago, there was a PC on every desk and every work station in virtually every office in America. As a result, cables needed to be run, server rooms needed to have supplemental air conditioning, and improvements had to be constructed. These improvements cost money, were built into the rent, and usually required lease terms of no less than 5 years. The shorter the term, the higher the amortization cost, and the higher the rent. And let’s not forget the mortgagee, whose loan was based on stable lease terms that often required minimum lease years. Mortgagees push for lease terms of no less than 5 years as it enhanced cash flow stability and reduced risk.
That was then. The landscape has clearly changed today.
Look around offices today and what do you see? Laptops abound, tablets are everywhere, WiFi dominates, and the cloud is replacing specially treated server rooms. The emphasis is on flexibility – in the lack of private offices, the use of “benches” instead of workstations, laptops instead of desktops, and employees coming and going on slightly irregular hours. The question then becomes – how do you translate workplace flexibility into lease term flexibility?
Lease term flexibility
Simply stated, the less the improvements to your space, the greater the flexibility you can build into the lease. Start up and rapidly growing companies can translate fewer improvements into flexibility in expansion, termination, and length of lease term. Here are you few tips to remember:
- When looking for office space, hire a broker that knows the market. (Yes, this is a totally self-serving comment as the authors are brokers. However, it is also an accurate comment because most users of office space are fundamentally clueless about lease rates, construction costs, lease structures, comparable terms, etc.)
- Look for existing space where there are already improvements built in – primarily ceiling, grid, tile and lights – as opposed to “Shell Space” needing ceiling, lights and ductwork. It usually costs more to improve shell space than existing space, and the goal is to keep construction costs down.
- Maximize demolition of existing hard wall construction. It is much cheaper to demolish a wall than to build one. Therefore, by selectively demolishing certain walls to create more open space, you save money and reduce the required construction investment.
- Build as few new offices and conference rooms as possible. This kind of construction requires addressing HVAC zones and ductwork, new electric wiring and cabling, and sprinkler drops. The more money that is spent by the landlord, the less flexibility.
- Consider paying some – or all – of the cost of improvements to obtain a shorter lease term or a termination right. This may be cheaper in the long run than having a long term lease for space that no longer works.
- Get an expansion option that requires the Landlord to give you an additional 25%-50% of space in the property if you need it, upon 6 months’ notice. If the expansion space is not made available, you have the right to terminate the lease.
- Negotiate a termination option that gives you the ability to cancel the lease upon a certain amount of prior written notice. Usually these options require the tenant to pay unamortized construction costs, commissions and some fees. However, if you have followed items 1 – 5 above, the cost should not be that great. And so you know, successor landlords may very well pay that cost for you.
The best deal…
Ignore the cocktail conversation that focuses on cheap rent as constituting the best deal. Someone once told us “you pay peanuts, you get monkeys.” The same is true in rent – if the rent is really below market, than there is a reason for it.
From a tenant’s perspective, the “best” deal addresses not only economics, but lease flexibility.
There are several ways to keep construction costs down to drive greater lease term flexibility.
For startup companies and fast growing companies, having a flexible lease with a variety of options trumps a cheap rent. You’ll pay more in the long run.