As Southern Nevada’s economy crumbled during the Great Recession, many business owners had to make dramatic changes to survive.
One strategy that emerged was lease renegotiation.
Working to renegotiate a lease agreement is a common savings approach, akin to refinancing the mortgage on a house. It can make good business sense – both for tenants and landlords – and can be an important tool in achieving profitability, real estate brokers say.
While lease renegotiations peaked in 2006 as Las Vegas’ economy crashed, they continue at a good clip today. With a 25 percent commercial vacancy rate in Southern Nevada, tenants have an advantage now that can help them score better real estate deals.
But how does a business owner renegotiate a lease? What goes into a successful pitch?
Real estate experts say lease renegotiations are a routine part of any landlord-tenant relationship. The key is to try to establish a win-win scenario for both the landlord and the tenant, said Taber Thill, senior vice president of the tenant representation division of the Las Vegas office of Colliers International.
“The first thing that I would recommend is having somebody abstract a lease, having a broker go through and look at critical clauses to make sure they have the right to assign or sublet and verify terms,” said Thill, who has been with Colliers for 11 years.
Brad Peterson, a senior vice president at the CBRE commercial real estate firm in Las Vegas, said about 90 percent of his clients have approached their landlords with restructuring pitches.
“I think 100 percent would like to be able to restructure and get their rates back to market,” Peterson said. But success “depends on who the landlord is and what term the tenants have left on their lease.”
Typical commercial leases run three to five years. Most enable tenants to renew or sublet the property.
When is the right time to renegotiate? The experts suggest that business owners keep a close watch on the market and see how their rent stacks up against others’.
“First, you should look at like properties to what you’re already leasing,” Thill said. “Find out what are the asking rental rates of those properties. Could I upgrade? Could I get a better property for less money? What concessions are being offered in the market? Those are usually telltale signs that you’re paying too much.”
“You don’t want to be among the very few who are out there paying these exorbitant rates compared with the market,” Peterson added.
And while some business owners may have the negotiating skills necessary to cut a good deal, Peterson said there’s no substitute for hiring a broker who knows the market and is experienced in winning concessions.
“Our recommendation certainly would be to get a real estate expert, adviser and broker on your side and actively go out to the market and look for alternative sites, and introduce that broker to the current landlord and say, ‘Here’s our broker, and here’s what we’re doing,’” Peterson said. “That does create credibility to the fact that, yes, we’re serious about potentially moving, even if it’s one, two or three years down the road. That also creates leverage. The landlord knows that you’re seriously considering leaving, whenever that may be.”
“I know landlords in the market right know that won’t give the tenant their best deal until the tenant says, ‘I’m leaving,’” Peterson continued. “Most landlords feel that most of the tenants are captive audiences and it’s going to be hard for them to leave, so they need to be shown that they really will leave if they don’t get the right deal.”
Commercial real estate agents use software to monitor the market and assess what’s available. When a prospective property is identified, they’ll make contact on behalf of the tenant and draft a proposal to submit to a landlord.
“A broker provides a buffer between the tenant and the landlord, and the broker has the local market knowledge that allows him to guide and instruct the tenant on local market conditions and what the rates are, what the concessions are and analyze their current economic financial situation,” Peterson said.
Often brokers provide a list of comparable properties and their prices to make a compelling argument for a client.
“But remember, it’s also about making it a win-win for both sides,” Thill said. “If the landlord thinks you’re going to leave in two years regardless and you’ve got two years remaining on your lease, they’re probably not going to work with you. But if they think you’re going to be around for a while paying that rate that they renegotiated, they’ll probably work with you.”
Here’s how the process works: Brokers develop a proposal that is signed off by the client. The landlord typically has a week to respond.
“It should be a pretty in-depth process,” Peterson said. “You’re going back and forth after the initial RFP with proposals and counterproposals until you finally reach an agreement.”
Once both parties come to terms, an amended lease agreement is drafted by an attorney, and the amendment becomes a part of the lease document.
Thill said he’s normally in landlord-tenant negotiations with three different clients at a time.
“More than rate right now, we’re seeing more of a trend when the efficiency of the space just doesn’t work,” Thill said. “It’s either too large or too small. That’s really the driver.”
Thill said many landlords like to keep their base rates high but are willing to offset rents by giving a tenant credit for improvements or for signing a longer lease.
“Some landlords may give you a year free on a five-year deal,” he said.
Typically, free rent deals come from landlords who want to lock down longer leases to assure their buildings will be occupied for an extended period of time.
“If you’ve got two or three years left in the lease, they may want an additional five years,” Thill said.
Having good credit and a good track record of payments also helps.
“It also depends on the creditworthiness of the tenant,” Thill said. “Is this somebody we know is going to pay the rent on time? Do we have to worry about them blowing out completely?”
Free-rent incentives have become more common as vacancy rates rise, Peterson said. In the past, incentives typically were reserved for lease renewals. Now, they’re being used to steal business away from competitors.
“There are landlords on new deals offering up to 12 months of free rent on a five-year term,” Peterson said. “One landlord I know basically sets up a six-year term with the free year on the outside of the term, so it’s basically a six-year term with 12 months of free rent. The rule of thumb in the market is at least a month of free rent for each year of the lease term.”
Sometimes a landlord will sweeten a deal with offers to renovate a property. It could be new paint and carpet, environmental upgrades or a total reconfiguration of the space. Improvement incentives are based on tenant need.
“It can be used as a concession or benefit to keep a tenant there,” Peterson said. “There are different pockets. There’s the tenant-improvement pocket, the free-rent pocket and the discounted-rental-rate pockets. Those are the three major economic deal points of every lease transaction.”
Negotiations that involve property improvements, however, often get drawn out because they involve planners, designers and construction workers, Peterson said. On average, the entire negotiation process should take between two and six months, Thill said.
“A lot of times, it’s a matter of how willing a tenant and a landlord are to come to a compromise,” he said. “And how quickly the attorneys can turn around the documents.”
While lease renegotiating has slowed, it’s not likely to end anytime soon with vacancy rates as high as they are. That isn’t so much the result of developers overbuilding as it is the devastating effect of the economy, Peterson said.
“Our feeling is the vacancy rate will come down – not very fast, but it will come down,” Peterson said. “It’s a supply-and-demand dynamic, and you haven’t had any new supply of any significance put on the market...for the last three or four years.”
Lower vacancy rates could make lease renegotiation more difficult in the future. And with recent upswings in the economy, landlords appear to be increasingly willing to hold out for higher rents.
“There are a lot of landlords in the market that don’t want to do long-term leases because they want to see if the rates go up,” Peterson said. “There are a lot of people who think the market is going to be a lot different in three years.”