When it is time to negotiate a new office lease there are important considerations that an office tenant must know in order to earn gain the most landlord concessions possible. To start with there are basic concessions that a tenant could earn from a landlord.
Standard Office Tenant Concessions
- Free Rent
- Construction Allowance
- Operating Expense Caps
- Right of First Refusal
- Early Termination
- After Hours HVAC Charge
- Parking Allocation
- Re-carpeting and Painting mid-term of lease
- Expansion Options
There are other landlord concessions that should be considered but for this article I am going to review the ones that I think are the most important. These include free rent, construction allowance and operating expense caps. If you want more information on the other items please contact me with your questions and I will be happy to answer them for you.
The word free is statistically one of the most noticed words in the english language. The opportunity to get free rent is higher when an office market is soft and the landlords are more aggressive but it can still be gained in a tight market. Most landlords will base their decision for free rent or rental abatement based upon the tenant’s creditworthiness and the length of the lease term.
During the last market downturn many landlord’s gave long free rent periods. In some cases they were up to 12 or more months. Unfortunately some tenants skipped their lease when the free rent period terminated leaving the landlord upside down on the deal. So if a tenant doesn’t have good credit or can provide a letter of credit the landlord will most likely avoid free rent.
The construction allowance is generally given in one of two ways. The landlord will offer a “turn-key” options which means that the landlord will provide all the architectural, construction labor and materials, permit fees and any other services necessary to build the tenant’s space that is required. The actual construction will be based upon an agreed upon plan that was pre-negotiated prior to the execution of the lease document.
Another option is to have a dollar amount construction allowance. This usually has an agreed dollar amount per square foot that is negotiated into the lease. The landlord will pay an approved contractor up to that agreed amount. In the event that the construction expense exceeds this construction allowance the tenant will need to pay the difference.
If you negotiate a construction tenant improvement allowance with an agreed upon dollar amount it is important to protect yourself. If the actual dollar amount isn’t exceeded and there is a surplus the landlord shouldn’t be allowed to retain the excess amount. Your rental rate includes the construction allowance amortized into it so the landlord should either allow the tenant to keep the additional funds for other construction or to potentially be applied to free rent.
To see why you would be leaving your money with the landlord please read this article that explains the yield analysis a landlord does to determine rental rates.
Operating Expense Caps
In addition to base rent most leases include an operating expense pass through. Usually a tenant would have a base year operating expense which is the total of the building’s common area expenses, taxes and insurance. The idea behind these expenses is that the base rent will include the costs to operate the building for the first calendar year of the lease. Any increases beyond this base year amount will be charged to the tenant, usually on a prorated basis.
So if it costs $7.00 for the common area expenses, taxes and insurance during your leases first calendar year, this is your base year amount. If the cost for the same services increase to $7.15 per year for the next year your lease would have a .15¢ increase. So based upon the unlimited exposure this system creates it is wise to ask for a cap on the controllable operating expenses. I usually ask for 3% – 5% depending upon the market conditions.
I know that there is so much more to discuss about this topic. If you have questions please contact me and I will continue more discussion about this important topic in a later post.