As real estate is typically one of the top costs for companies, here is a list of the top 10 mistakes tenants make in leasing office space. The real estate decision, however, goes beyond cost. It also impacts the bottom line in terms of employee productivity as well as employee retention and recruitment which is becoming more and more important today. This is based upon the joint experience of me (being an attorney by background, with 20 years of representing office tenants locally and nationally) and nationally recognized commercial real estate attorney Ted Yi, Co-Managing Partner of Quarles & Brady, with over 25 years representing office tenants and landlords (locally and nationally).
- Time Constrained. In any negotiation, time is the most valuable commodity. Tenants frequently underestimate the time necessary to conduct a property search, perform needed due diligence, negotiate business terms, draft and negotiate lease documentation and construct new office space. Generally, tenants should allot 12 to 18 months to secure a new office; however, a longer-time range may be necessary to capture those buildings that are proposed and require construction. In a suburban market, constructing a new building from start of negotiations may take 2 – 3 years. While in a major downtown market like Chicago, you are looking at 5 – 6 years. For tenants exploring renewal, they must keep in mind their notice of renewal deadlines and adjust their due diligence period accordingly. Finally, tenants should also apply the same timeframe to evaluating any early termination or contraction options they have which may allow the tenant to renegotiate their lease to more favorable market terms.
- Not assembling the right team. Leasing office space touches on various areas of expertise which many tenants do not possess, but landlords do as it is their core business. To level the playing field, tenants are well advised to assemble a team compromised of an office tenant broker, project manager, architect, engineer and commercial leasing attorney. The office tenant broker can serve as “quarterback” for each of these team members and provide the tenant with a single point of contact.
- Lack of Internal Consensus and Focus. As a real estate decision affects multiple stakeholders in an organization, it is important to develop consensus on the objectives and key drivers among the company’s stakeholders. An internal single-point of contact is needed to maintain a clear line of communication with the team.
- Not defining space needs. Given changes in technology, many companies today are able to effectively use a lot less space than a few years ago. Before embarking on a search for space, tenants should work with an architect to develop a space program which will forecast current and future space needs.
- Lack of flexibility. Given the rapid change in business today and long-term nature of most office leases, tenants need flexibility to align their office space to their business needs. Early in negotiations, tenants should look to maximize flexibility with rights to contract, expand, terminate, extend and sublease excess space as needed. While such rights are an uphill climb with most landlords (and their lenders), savvy tenants gain the most by pre-negotiating these flexibility rights while competing landlords are trying to land the deal.
- Not independently verifying building infrastructure. This is particularly important when tenants are exploring older office buildings where the mechanical infrastructure might be inadequate for certain tenants. Proper due diligence helps avoid future surprises.
- Not considering all occupancy costs. A tenant’s occupancy costs go beyond the base rent. A major component is the treatment of “Operating Expenses” and “Taxes”. If not carefully drafted, landlords may have a lot of latitude on what they charge a tenant as an “Operating Expense” or “Taxes”. There may be unexpected costs buried in the definitions which can play havoc with the tenant’s budget. A well advised tenant will have a laundry list of exclusions to what is an “Operating Expense” and “Taxes” and will also have an annual cap on increases in such charges. They should also have the right to audit such charges.
- Lack of Competition. Particularly when a tenant is exploring renewal versus relocation, tenants must engage multiple landlords to compete for the tenant’s business. It is only through this “auction of tenancy” that the tenant will obtain the most favorable lease terms.
- Inadequate attention to Tenant Improvement Process and Lease Language. Many tenants underestimate the complexity and cost of an office build-out. In the Chicago area it is not uncommon for the interior construction to exceed $50 per square foot for an average build-out. Higher-end construction will approach and exceed $100 per square foot. With this much money at stake and the operational importance to the tenant’s business, tenants must carefully perform their pre-lease due diligence of space planning and construction pricing to avoid any surprises. Of equal importance, tenants must negotiate the lease construction language (i.e., “Work Letter”) to fairly allocate responsibility between tenant and landlord and make clear the landlord’s obligations. In particular, hidden fees and costs should be negotiated and responsibility for delays and costs overruns clearly allocated.
- Loosely Defined Summary of Terms or Letter of Intent. The best time to negotiate key lease terms is before you select a final building and obtain the draft lease. Once the deal is finalized, you’ve lost a lot of leverage. While it is not feasible or practical to negotiate all lease terms, there are key lease terms (business and legal) that must be pre-negotiated into a detailed Summary of Terms or Letter of Intent (“LOI”). While the LOI is typically non-binding, a well documented LOI can serve as the “blue print” for the lease draft and save the tenant considerable time and negotiating capital.
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