Friday, March 31, 2017

Your Rent is Above Market - Now What?

Image Attribution: www.emeraldhs.com
Recently, I've encountered several situations involving an occupant paying an over market rental rate. The occupant's desire is to remain in the building and renew their lease. But, there is a problem. Storm clouds are rumbling on the horizon and a face off between owner and occupant is quickly approaching. So now what?

First, let's first determine how the over market rent occurred?

Leases originated before the financial meltdown of 2008 were inked at the prevailing market rents. These rents were at a high water mark.

Most, if not all of the leases, contained annual rent escalators which increased the rates over the term of the lease. Shortly after the crash of 2008-2009, market rates plummeted.

So hypothetically, if the lease an occupant signed in 2008 was a five year lease, gold! When renewal time rolled around in 2013, occupants were pleasantly surprised the market had moved in their favor and now rates were cheaper than they were paying. In many circumstances, owners gladly renewed occupants at reduced rates to insure the owner's cash flow would continue - albeit at smaller amounts.

However, if the term of lease was seven to ten years - the opposite is true. Occupants have paid rent in excess of market rates for the term of their lease AND now face renewal in an over heated rental market. Ouch!

Owners, who were anxious to renew leases at cheaper rates in 2013-2014 are now quite bullish and unwilling to budge on the renewal rate they demand. The resulting tug o' war between owner and occupant plays out something like this:

Owners point to the vacancy for industrial buildings in Orange County - 98 of every 100 are occupied - and a better spot will be hard to find. Oh by the way, rents are increasing as evidenced by the recent lease comparables.

Occupants quickly counter with the fact they have faithfully paid an above market rent for the term of their lease and consequently deserve a break - in the form of a rent reduction.

Owners return the argument by reminding their occupant of the cost, disruption, and inefficiency of moving.

Occupants respond with the owner's cost of originating a new lease - down time with no rent, free rent with a new occupant, potential upgrades required by the new tenant, real estate fees.

Now a stand-off akin to wild west saloon gun slingers ensues.

The man who draws first generally wins.