1. 8111 Rockside Road,
Suite 250 LEASE RENEWALS – The Last Option
Cleveland, Ohio 44125
Phone: 216-524-0710 Why shouldn’t your company exercise its renewal option? The answer to this
Fax: 216-524-0711
question is simple – because, in many cases, depending on market conditions,
better deal terms may be available if you strike a new deal with your landlord.
Unfortunately, renewals are often looked at as matter of fact, standard modus
operandi, easy to deal with and move on. There are common themes behind
the rationale used to justify exercising renewal options. Many times, the person
responsible for real estate is too busy and doesn’t have the time to deal with the
issue and properly focus on the renewal opportunity. Money is undoubtedly left
on the table. Other times, the same individual will have no intention or interest in
moving. By default, they exercise their renewal instead of opening up negotiations
with the landlord. Money is undoubtedly left on the table. Worse yet, the individual
will be hesitant due to concerns related
Damon M. Taseff to legal and real estate fees or even Whether you are
landlord relationships. Ultimately, they
Principal
exercise the renewal option because
managing a complex
Allegro Realty Advisors, Ltd.
216-524-0710 x112 they believe it will be, in the short real estate portfolio
dtaseff@allegrorealty.com term, a less expensive proposition.
Again, money is undoubtedly left on or are responsible for
the table.
the lease at a single
Whether you are managing a complex location – having a
real estate portfolio or are responsible
for the lease at a single location –
renewal option is not
having a renewal option is not reason reason enough to
enough to exercise it. The renewal
option creates a “not to exceed” exercise it.
guarantee, a worst case option, from
where you can work to negotiate and create a better set of terms for you and
your organization. It guarantees you the right to your space at pre-determined
Kevin Yates terms, so the landlord cannot lease your space to another tenant and force you
Manager out. Even if the lease was properly negotiated, the renewal terms very easily
Allegro Realty Advisors, Ltd. could have been glossed over, resulting in landlord-friendly renewal terms.
216-524-0710 x108
kyates@allegrorealty.com Rental rates are functions of debt, interest, equity, operating expenses plus any
amortized improvements or commissions and profit. A landlord will always be
willing to make cosmetic alterations such as installing new carpet and paint to
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www.allegrorealty.com accommodate a new tenant. Commissions will also need to be paid. This is at
to receive the latest real a minimum. In order to attract new long-term tenants, a landlord very often
estate research, analysis,
and news from Allegro
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2. has to make a much larger investment, including demolition and construction
costs within the suite. These costs will be amortized and added to the rent. For
example, if a landlord needs $20 per square foot to cover debt, interest, equity,
operating expenses, an additional $20 per square foot would be amortized and
added to cover the improvements. By the end of the lease, the landlord will have
been reimbursed for the cost of all improvements.
In some cases, rent rates increase successively year over year based on a
predetermined factor. This factor could be a fixed step percentage rate or tied to
the consumer price index. The same can be said for renewal option rent rates.
They are also typically based on successive year increases, and tend to build from
the original rent rate. The table below shows a 5-year lease with a $25 rent rate
that increases 3% year over year. The renewal period for years 6-10 follows the
same trend, increasing 3% year over year.
As discussed above, the landlord amortized $20 per square foot during the
original 5-year term to reimburse costs associated with commissions and tenant
improvements. By the end of year 5, these costs were completely recovered.
However, the rent schedule does not reflect this recovery. Instead of realizing
relief in years 6-10, the tenant continues to pay an increased rent, as if there are
comparable new improvements to be amortized over the renewal period. The
table reflects the expiration of the amortized $20 per square foot and resulting
corrected rent rate adjusted for 3% year over year inflation. The table shows very
clearly how these renewal option rental rates can be deceiving.
When a landlord agrees to a renewal option, they lose flexibility and handcuff
themselves in the future; an unknown future. Because of this, the rent rates
associated with these renewal options rarely are in the best interest of the tenant.
If the landlord is astute, rent rates will be in priced in excess of the expected
market and many times will not reflect fair relief associated with the completion
of fully amortized improvements within the original term, as discussed above.
The inaction or lack of desire to capitalize on this inequity ultimately costs you
money.
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3. It’s very easy to become complacent and renew according to the previously
negotiated terms. In some cases, these terms may have been negotiated up to 10
or 15 years ago. It is always best to take the time and press the landlord for better
terms than already granted in the renewal option. If the real estate requirement is
managed correctly and dealt with well in advance of critical notice dates outlined
in the lease, there will almost always be better results for the tenant.
So think twice the next time your lease expiration is approaching. Don’t fall into
the renewal option trap. Realize that it’s the quick and easy solution, but also that
it will likely cost you and your organization money in the long run. Make the right
decision for your company and take the money that’s sitting on the table.
***
Allegro Realty Advisors, Ltd. is a commercial real estate services firm that serves
corporations across the U.S. from our Cleveland, Ohio headquarters. We can help
your organization whenever real estate requirements arise and you need deep
industry and technical experience. For a better understanding of our commitment,
service and experience with other clients like yourself, visit us online at
www.allegrorealty.com.
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