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The larger the tenant, the better the lease deal they should do, right? Not always. Although their tenancy is more meaningful to a commercial landlord than an average tenant, there are tragic pitfalls in their renewal processes that can impact how successful their negotiation ends up being. Here are the reasons why big companies tend to do the worst office lease renewals.
Small business owners are grinders and get the most out of their office lease renewals. Every dime saved is a dime that will live another day in their pocket. Commercial real estate agents will tell you that they prefer working with a CFO for a 10,000 square foot requirement than the founder of a 1,500 square foot company – the project will take less time and go more smoothly.
The CFO will want to put in a reasonable effort, but ultimately the lease for the office space is an annoyance that comes along every 5 years. For the small business owner it could be a hill they decide to die on.
There has been a growing trend for companies that have multiple locations to centralize commercial real estate decisions from head office. This makes sense for a number of reasons:
2. Streamlined decision making
3. A uniform real estate strategy
It really is remarkable that when the local managers are involved in the site selection process just how different their views are than the centralized real estate manager in head office. And by different views, I mean that local managers tend to be extremely unsophisticated in real estate. So it does make sense for them to be guided by someone from head office that actually has real estate expertise.
It is not the same as engaging a commercial agent, conducting tours, knowing the area and meeting with the landlord face to face to discuss the office lease renewal. If the landlord’s contact with the tenant’s real estate manager is simply pushing a proposal back and forth over email, the landlord likely knows that:
1. The real estate manager would like to avoid travelling to this site.
2. There are other sites this person manages – travel would be reserved for the locations that are actually interested in relocating.
3. The tenant most likely does not have a strong grasp on the market.
Even if the company engaged a commercial real estate broker, there is a lack of credible negotiating leverage here.
When a company reaches a certain size or stature, they get used to being able to flex some muscle with suppliers. Commercial real estate is a little different, given the pain involved in actually transferring to another supplier (landlord). Tenants usually overrate the rent they pay, their size, and the value of their tenancy, and underrate how indifferent landlords can be to tenants staying or going (or at least the indifference they convey in the negotiation).
Even a decent sized tenant is usually only one of many in a building, and commercial landlords typically own more than one building. So even a tenant that represents 20% of a building may only be 3% of the landlord’s overall portfolio.
Moreover, lease expiry dates are staggered, so landlords have a diverse range of dates for office lease renewals. It’s not like every lease comes due at the end of each year and the landlord has the threat of every tenant leaving at the same time. About half of all space is leased for 5 years and the other half for 10 years, so the average cycle time is 7.5 years. In other words, at any given time when a tenant is renewing, the average expiry date on other spaces is 7.5 years into the future. This keeps the landlord in a position of being comfortable, safe, and in a position of power.
The bigger a company gets, the slower it moves. The small business owner has the right to make impulsive and emotional decisions. If she feels she is being treated unfairly on the office lease renewal she can move out of spite. She can hire her own moving van and have friends help with the move.
Smaller spaces have less construction required and smaller tenants tend to not have any office planning standards, guidelines or requirements. So a last minute move is possible with a small business and therefore a last minute take it or leave it offer has clout. If a small business is a kayak, big companies are like cruise ships. If a big company has not renewed their lease and there is 6 months left on the lease (or more), they have lost all leverage.
It is not about what kind of deal a company gets. It is about what kind of deal they think they get.
If the out of town decision maker is getting all of his market information from the landlord, then that information is biased – the landlord will be presenting that information in the best way to let the tenant believe the offer is fair. What’s more is that when the real estate manager has to justify the deal, management will ask for the “facts” but generally it is not asked where the facts came from.
Here is how a typical conversation regarding a lease renewal from head office:
Senior Management: “So the office lease renewal rate is fair market rent?”
Real Estate Manager: “Yes, the last three deals in the building were all at $25 and we were able to get $24.”
Senior Management: “Great, let’s proceed with the office lease renewal then.”
What should also happen is this:
Senior Management: “By the way, how did we find out what the other deals were done at?”
Real Estate Manager: “Well, umm…the landlord told me.”
Senior Management: “So the person we were negotiating with, the one who benefits from us renewing, was the source of our market information? Did we tour other locations? Did we hire a real estate broker or at least scout out other sites to see what the rates are? If other tenants renewed at higher rates, did they receive free rent or a cash allowance?”
In many companies the senior management is far enough removed from real estate that they just do not know what specific questions to ask, so the narrative is controlled by the real estate manager. And often is the case that the real estate manager will just manage the optics. And many big companies will continue to pay more than they should.
Best of luck with the office lease renewals out there folks! If you need any assistance you know where to find us :-).