Every employer has lost a great employee that takes it by surprise. The employee never complained and over the years seemed to be perfectly happy with his arrangement. In the exit interview, however, the boss finds out that the employee got an offer from someone else that was too good to refuse. Only then did the employee realize that his current compensation undervalued his worth. In many instances, if the boss knew how underpaid the employee was, she would have done something about it. Most employers want to do the right thing and treat their people fairly. However, if an employee appears happy with the deal he has, the employer has no reason to make a material adjustment to the compensation scheme. Only when outside competition is introduced to an otherwise closed compensation system does everyone find out what a fair deal truly is. The same thing holds true for tenants who do “friendly” lease renewals without exposing their requirement to the open market.
Landlords are in the business of leasing space and the last thing they want to do is lose a good tenant. However, sometimes they fail to appreciate the value that a long term tenant has been providing them and, as a result, the tenant ends up getting less than what they deserve. Again, it’s not necessarily a matter of malfeasance on the landlord’s part; it’s simply that if the tenant appears content and continues to renew its lease in the building, the landlord has no reason to materially improve the tenant’s deal. Like the employer in our opening example, it has no reason to offer more if the other party seems content.
The fact is that most tenants who have continued to renew their leases over time without actively competing their deals in the market are underappreciated by their landlords. Landlords make all of their money on renewal deals–sometimes two to three times more than what they make on new lease deals. By renewing a tenant as opposed to replacing it with a new tenant, the landlord avoids vacancy, minimizes required build out costs including cash allowances and concessions, and often secures a premium rent if the tenant decides not to compete its requirement in the market. Though the tenant thinks he’s happy, he usually has no idea how much he is saving his landlord by renewing, nor is he aware of how valuable his tenancy is to other landlords.
Let’s use an example to illustrate the typical economic benefit to a landlord when a tenant renews. Let’s assume that if the current tenant vacates, it will take the landlord 24 months before it starts getting rent on the space from a new tenant. This rent interruption period includes the required marketing period, the build out period for the new tenant and a free rent period. Let’s further assume that the new tenant will need to totally rebuild the space to serve its needs so it will demand an improvement allowance from the landlord of $40/sf to defray these material costs. A renewing tenant, however, may only require $15/sf to freshen up the space if it still works from a layout perspective. If the space is 10,000sf and the rent is $30/sf, what is the value of the renewal to the landlord assuming it could otherwise renew the existing tenant at $30/sf? The landlord avoids two years of rent loss which is worth $600,000 (2yrs x $30/sf x 10,000sf) and saves $250,000 in tenant improvement costs (($40/sf-$15/sf) x 10,000sf). That’s an $850,000 benefit to the landlord. In this example we are assuming that the renewal rent is equal to the rent the new tenant is paying which is probably a very conservative assumption considering the new tenant competed his requirement in the market and the renewing tenant may not have. Knowing that the landlord saved $850,000 on the renewal, would the tenant still think it’s fair that he is paying the same rent as a new tenant would pay?
How can a tenant obtain the information he needs to make an educated decision? The tenant needs to compete his deal in the market and run a comparative financial analysis of his options. Most tenants cannot do this on their own.
In speaking to potential clients, we sometimes hear that they don’t need or want a broker because they are friends with their landlord– they can do the deal themselves. Some tenants claim that they do not want to impose a broker intermediary in their negotiations and possibly upset the apple cart or create friction in their friendship. They trust they are getting a good or fair deal when they renew. The problem, however, is that in this type of closed system, neither the landlord or the tenant truly understands the value of the tenancy.
Tenants should not view a broker or a competitive lease process as a potential fly in the ointment that will jeopardize a landlord relationship. Instead, they should view it as an opportunity to see what their tenancy is actually worth to their current landlord and other landlords so that both parties are fairly informed when making decisions. If it turns out that the tenant has been underappreciated over the years (i.e., they have not shared in the $850,000 of savings to their current landlord), it does not mean that the landlord was taking advantage of the tenant. Like the employer in our original example, he just assumed all was fine because the tenant never asked for more. In most cases, if a tenant can demonstrate to its current landlord that other landlords are offering him much better terms or that he is not equitably sharing in the value he’s creating, the current landlord will want rectify the situation rather than see the tenant leave.
In business, as in life generally, we tend to think everything is fine if no one is complaining. We also tend to under appreciate those who have been with us for long periods of time. Knowledge, however, may reveal that we are not treating people as fairly as we thought. Just as an employee may not know his true worth until another company makes him a better offer, a tenant won’t know what his tenancy is worth until he takes his requirement out into the market and gets proposals from other landlords. Likewise, unless he understands the true value he is providing to his current landlord, he may not be able to assess what a fair deal is for his renewal.
Time and again we see that tenants who do “friendly” renewals without competing their requirement in the market end up being underappreciated by their landlords. It’s not that their landlord is taking advantage of them or their friendship; it’s just that, like the employer in our example, they are continuing an arrangement that appears to be working for everyone. If, however, the tenant can demonstrate that other landlords are offering more for their occupancy than they have been receiving, their landlord will want to make things right. That’s what real friends do.
For more information contact Glenn Blumenfeld