Friday, August 15, 2014

My #CRE lease expires in 18 months...now what?

Image Attribution: www.ownersrepny.com
Unless you own your commercial real estate location, you will face a lease expiration.

If your company does a series of short term leases...twenty four to thirty six months...this expiration will seem to occur overnight!

If your company takes a longer view of your lease obligations...five to ten years...then your lease term will eclipse or straddle many market peaks and valleys.

Regardless, of your company's attitude about the length of your leases, you will face an expiration.

How and when you plan your direction at lease expiration time is the purpose of this post.

...but first, allow me to digress. I provide Location Advice to owners and occupants of industrial buildings in Southern California...AKA, I sell and lease commercial real estate for a living and have since 1984. I have advised a multitude of companies large and small on new leases, lease renewals, and lease cancellations. This qualifies me as some sort of an expert...if I can only remember...

As with any business strategy, an appropriate lease expiration strategy can save you time, money, and aggravation. I would suggest following the steps below, when you are 18 months from expiration:

Gather ALL of the important information: Find your lease. Make a copy. Put it on your desk. Vow to read it. You are interested specifically in any options to renew, rights of first refusal to purchase, rights of first offer to purchase, expansion rights, hold-over clauses, termination rights, commercial real estate brokers that were involved in the transaction, etc. Well in advance of your lease expiration (18 months) is a GREAT time to gather this information.

Engage great help: If a broker represented you in the original lease, there may be clauses contained  whereby she is owed a fee in the event you renew your lease...even if no option to renew exists. Check this out! Regardless of your experience (good or bad) with the brokerage representation, a fee may be owed by the owner of the location for any expansion or renewal. If the experience was good...no issue...engage that broker to assist you in mapping the renewal strategy...after all, she will be paid. If the experience wasn't so great, you can opt for other representation...BUT, the owner will still owe the previous broker a fee...therefore any brokerage help you engage will be a cost that you, as the occupant, will bear. The extra $ could be worth it! If you dealt directly with an owner to construct your lease...DANGER, Will Rodgers! Please engage a commercial real estate broker to assist you in negotiating a renewal.

Analyze your current operation: Chances are, when you leased your present location, certain business realities existed...customer locations, manufacturing processes, methods of shipment for raw materials and finished goods, hours of operation, number of employees, dollar volume of business, etc. How have these realities evolved since your lease originated? If you were told that you couldn't renew...how would that affect your operation? Would you face significant improvement cost in a new location? Would moving costs be excessive? If so, you might be better served owning a location...depending on other factors in the market...avails, interest rates, etc.

Take a look at your crystal ball of future business: What is your best estimate of your business in 18 months from today? How does the location mesh with the crystal ball? How long can the location efficiently house the operation...past the 18 months?

Assess the commercial real estate market conditions: Ask your broker/partner to assess the market for you as if you were moving locations today. With the same criteria as your present location, how many avails are in the market? What are the three most recent lease comparables? Is the market up or down trending? Is your present lease rate above or below market? Ask that your broker/advisor send you an updated list of avails and comps each month for the next six months.

Be realistic: If you are paying a rate above market, weigh the difference (between the market rate and your rate) vs. your cost to move. As an example, if  you are $.15 per square foot above market, you occupy 20,000 sf and your cost to move is $50,000...your incremental cost is $.07 per square foot over a three year lease. ($50,000/36/20,000). Conversely, If your lease rate is below market, understand that you may be strapped with a rent increase come renewal time. There are ways to stem this increase which will be a topic for a future blog.

Figure out the BEST time to approach your property owner: During 2009-2011, we discovered that many occupants were well above market in the rates that they were paying. The whole idea of a blend and extend evolved. The mechanics of a blend and extend were that additional term was committed to today in return for a reduction in rent. Occupants were happy to commit to the term past their original expiration, in return for a cost savings today. Owners were happy to avoid a costly vacancy in 18 months...WIN WIN. If your rate is below the current market rate, this doesn't work as the owner will wait for the expiration to extract more rent.