It was the best of times. It was the worst of times. As a Commercial Tenant, how do you prepare for both?
You need to build flexibility into your Lease by negotiating wisely.
The future for your company, partnership or non-profit may be rosy, uncertain or troubled but we hope you’ll grow and become even more successful. For the best of times, you need to protect your upside by getting Rights to Expand the size of your leased Office, Flex or Industrial space.
Expansion Rights come in several flavors, including Fixed Options, Rights of First Refusal (“ROFR”) and Rights of First Offer (“ROFO”). In some instances, you can even combine two of these rights, such as a Fixed Expansion Option that later converts to a Right of First Refusal or Right of First Offer if you don’t elect to exercise your Fixed Option within the specified/fixed time frame.
Expansion Rights can be one-time or Continuing Rights after a fixed date in the future, say, 36 months into your Lease Term.
However, to gain the maximum flexibility as a Tenant, you also need to protect your downside in case things don’t go as well as planned. It’s very valuable to have a pre-paved pathway to escape your lease.
A Tenant can protect both its upside and downside with a few smart lease provisions. Nevertheless, most Tenants first seem to put on rose-colored, optimistic lenses and address only their upside, which is Expansion Space for growth.
Protecting Your Downside
To protect your downside as a Tenant, you need a Right to Cancel or Terminate your lease and a Right to Contract (downsize) the rentable square feet (RSF) in your Premises, while otherwise remaining in place.
Having a Right to Cancel or Terminate your lease could potentially have a huge upside, too, and help with the future the sale of your company for top dollar because the acquiring company might want to consolidate operations elsewhere. This happens a lot in mergers and acquisitions.
Yes, there is a cost to cancel or terminate a lease, including all or a combination of the following items: unamortized or unearned tenant improvements paid for by the Landlord; the Landlord’s unamortized or unearned marketing costs; and maybe even a pure penalty of three (3) to six (6) months of NNN or gross rent. Sometimes the Landlord might even negotiate for an interest rate on the amortization of the tenant improvements and marketing costs over the Lease Term.
However, if you don’t cancel, terminate or contract your lease, then there’s no cost to you at all.
Rights to Cancel, Terminate or Contract are often scheduled to occur after the 36th or 60th month of a Lease Term.
They can be one-time rights (use-it-or-lose-it) available only at a set date or a “rolling” right that can be exercised at any time after, say, the 36th or 60th month of a Lease Term. We especially like rolling Rights to Cancel or to Contract for MacLaurin Williams’ Clients. The Right to Contract could be considered a partial escape, if that might work better for your organization than relocating.
In order to exercise a Right to Cancel/Terminate or to Contract, usually a Lease requires that a Tenant provide its Landlord with three (3) to nine (9) months’ prior written notice. Of course, the shorter the notice period required, the more flexible the situation is for a Tenant to escape.
How Rights to Cancel & Contract Become Bargaining Chips
In addition, Rights to Cancel, Terminate or Contract can prove to be very valuable to have in your pocket for protecting your upside as future bargaining chips with your Landlord. They could be used later to negotiate for a higher tenant improvement allowance, more free rent and/or reduced rental rates. These rights could provide just the leverage we need to negotiate for your Expansion Space and even a Lease Renewal. Just know that using your Rights to Cancel, Terminate or Contract as a bargaining chip will likely result in having to dial them back or more probably give them back to the Landlord as part of a quid pro quo.
This can be particularly attractive to a Landlord that wants to sell or refinance its building, since Tenants with Rights to Cancel, Terminate or Contract actually devalue the Property to a degree.
There is another very valuable way to protect your upside with a Right to Cancel/Terminate and use it as a powerful bargaining chip. It potentially allows a Tenant to renegotiate its lease at an interim point during the Lease Term, say, after three (3) years on a five-year Lease Term. See what the Landlord might be willing to do to prevent you from exercising your Right to Terminate, hopefully something better than what’s already in your lease. The Tenant gets the benefits of a five-year or longer Lease Term with what amounts to a right to renegotiate if the market then favors the Tenant. In essence, a Tenant can’t go wrong by having a good Right to Cancel or Terminate.
We’ve even negotiated a Right to Cancel/Terminate for a Tenant on a New Lease and then promptly sold it back to the Landlord for $125,000 before the Lease was even executed.
It is usually difficult to negotiate a Lease Renewal and have a Tenant’s Right to Cancel/Terminate and/or to Contract extend into the Tenant’s Renewal Term. It happens but it’s rare because Landlords try to avoid granting such rights in the first place, but if they agree to them, then they try to make them disappear as fast as possible.
If a Tenant or its 100% Tenant’s Agent can successfully negotiate Rights to Expand, Cancel, Terminate or Contract, then we strongly recommend that it do so.
Would it be worth it to a Tenant to pay a little more per RSF to have all of these rights? Yes, sometimes, but it depends on the nature of a Tenant’s business model, its industry and the future exit strategy of its Owners, Partners or Key Managers. Frankly, we’ve never had a Client/Tenant have to pay more for Rights to Cancel/Terminate or to Contract, but there’s a first time for everything.
Why 100% Tenant Reps Negotiate Better Flexibility Rights
Tenants need to keep in mind that their interests are often diametrically opposed to Landlords’ interests. Landlords want to obtain the highest rental rates possible, while Tenants want the lowest rental rates.
Landlords want to grant as little flexibility as possible, while Tenants benefit from having maximum flexibility. Tenants should want as much flexibility as they can negotiate. That is one of the major benefits of signing a longer-term lease with a carefully crafted Right to Cancel or Terminate.
Getting a Right to Contract is a bonus for most Tenants and having one can actually prevent an unnecessary relocation.
100% Tenant Representatives are far better at negotiating and winning Rights to Expand, Cancel/Terminate and to Contract for Tenants than are Traditional Commercial Brokers because the latter are too sympathetic to the plight of Landlords. Traditional Brokers are fully aware that Landlords usually despise granting any of these Flexibility Rights, but particularly Rights to Cancel/Terminate and to Contract, so they simply won’t push hard enough to risk annoying or aggravating Landlords.
Because Traditional Brokers often want to list the Landlord’s property for sale or for lease. Unfortunately, Traditional Brokers too often have another conflicting agenda, of which Tenants are frequently not aware. This simply is not the case with 100% Tenant Reps, who avoid conflicts of interest like the plague that pervades the Commercial Real Estate Industry.
The first time that a Tenant or its 100% Tenant Rep asks for Rights to Cancel/Terminate or to Contract, Landlords and Landlords’ Listing Brokers usually ignore the request or simply pretend they didn’t hear it. That’s to be expected, so just ask again and maybe even a third time. Still, Commercial Landlords won’t always agree to Rights to Cancel/Terminate or to Contract, so just ask the next Landlord.
It’s interesting how often a Landlord that said “No way” will come around if a Competing Landlord will say “Yes.” Persistence and patience often pay off handsomely when negotiating to win Flexibility Rights for a Tenant. Be aware, though, that some Landlords just won’t bend their positions and offer flexibility to Tenants. It’s either their way or the highway. You can’t win every battle, so it also pays off to know when to retreat and look elsewhere.
We identify the most flexible Landlords and then negotiate hard for Tenants to have it their way. Contact William Gary, MBA, MIM, via cell +1 303-901-1108 or wgary@MacLW.com to brainstorm confidentially about your workspace situation and how we can help you to gain valuable flexibility. As 100% Tenant Representatives, MacLaurin Williams Worldwide and our offices can advise you in nearly eighty (80) major markets.