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It is less expensive to keep an existing customer than it is to gain a new one. So renewing tenants should be a priority for commercial landlords. In the commercial real estate game, losing an existing tenant not only means a loss of revenue, but the following costs will be introduced to the landlord:
1. Realty taxes and operating costs for that space will now have be paid by the landlord, not the tenant who occupied the space. For example with a 2,000 square foot tenant who paid $15 net rent and $12 additional rent, the landlord not only loses $30,000 in annual net rent, but now actually has to pay $24,000 annually to carry the cost of that space.
2. Demolition or renovation of the space to make it marketable for the next prospective tenant. Demolition is typically $5-$10 per square foot.
3. Free rent and or a tenant allowance as an incentive to lease the space to the next occupier.
4. Real estate brokerage fees to both the landlord's agent and the co-operating broker.
Here is how it can really add up for the landlord:
All of this should mean that landlords should crawl over broken glass to keep their renewing tenants, right?
No so fast.
About 80% of tenants end up renewing their lease. Often without a real estate broker, lawyer, or an online commercial lease review company. The reasons for these renewing tenants are consistent and predictable:
1. New space typically requires quite a bit of fixturing which is both expensive and is a time-consuming project.
2. There are no moving costs associated with renewing.
3. It is a lot of work to search for a new space and negotiate a new lease.
4. Potential employee attrition.
5. People are too busy focused on their business.
6. Status quo.
Here is how moving to a new office can add up for the tenant:
Landlords are well aware of these factors. The cost to switch for the tenant is high.
Unlike other industries in which the customer can easily switch by driving to another store, or clicking away from one website to another, businesses are well anchored to their spaces. In the case of retail, this factor is multiplied as location is so much more of factor than office or industrial space.
The end result is that since most tenants are captive, most landlords treat them that way and can get away with charging premium to renewing tenants, while offering a discount to attract new tenants.
Some landlords try to extend an olive branch to tenants in the right to renew clause, by stating that the renewal rental rate will be at 95% of fair market rent.
While that sounds like a good deal for the tenant, the reality is that most new tenants are receiving a much better deal as their lease will likely have attractive inducements like free rent and a tenant improvement allowance.
For example, a renewing tenant paying $20 net may have a right to renew at 95% of market in their lease. Current market may be $25 and their renewal rate will therefore be $23.75. But new tenants may be achieving $25 net rent, plus a $20 tenant improvement allowance included in the rental rate.
That makes their effective rent less than $23.75.
So what is the best strategy for minimizing the renewal premium?
It takes a long time to relocate an office, retail or industrial use. Six months is really the minimum amount of time, but 12 months or earlier is more ideal. This will allow you to:
1. Become fully educated on the market.
2. Not be in a rush.
3. Give you time to exercise your option to renew as a last resort. You should just try to work out a new deal with the landlord prior to your notice date (we go into more detail in his post: Do Not Exercise Your Option to Renew.
4. Show your landlord that you are taking this project very seriously and it will not be a slam dunk renewal for them.
5. Investigate options that are currently available for lease, but not vacant. For instance, a perfect option that is still occupied for the next 8 months but is being marketed for lease today.
6. Account for any construction required in a new space. General rules are: one month for design and budgeting, one month for mechanical and electrical drawings, one month to wait for building permits, two months to construct and one month for a buffer.
To have the credible threat of being able to relocate to another property, your timeline should look something like this:
In order to avoid being treated as a captive audience your landlord must be fully aware of your indifference to staying or going. Perhaps if you were to move you would take on less square footage. Maybe you can live with downgrading the building image. Or perhaps you are fine with moving to a worse location.
You should casually make your landlord aware that you have options and as such the landlord should sharpen his pencil to ensure he is in the mix on keeping your tenancy.
Renewing tenants who hire a commercial real estate agent will really enforce the message above. If you are serious about moving, you will have an advisor on board investigating alternatives. Even if you are 99% certain you would like to extend your lease, that is the last thing you want the landlord to find out. The mere presence of the broker will dramatically improve your bargaining position.
Your agent may even procure some options that may change your mind, in which case you can become the new tenant that gets the better deal.
Still stuck? Try out our online commercial lease review service to get you on track for your lease renewal!