In office lease negotiations, like most other negotiations, there’s the “sticker price” and the final deal terms. As to the latter, landlords and office brokers frequently talk about comparable lease transactions, a/k/a, “Lease Comps”. Many tenants confuse the reliability of Lease Comps with those of property sales. While Lease Comps have some validity, they need to be taken with a grain of salt.
How we measure office space is changing. The most widely accepted measurement standard by the Building Owners and Management Association (BOMA) recently released a new measurement standard for office space utilizing two different methods. The biggest change is the method of creating a single-load factor for all floors in an office building; in general terms, a “load factor” is the ratio of common areas added to a space’s useable area (i.e., the actual measurement) to arrive at its rentable area (i.e., basis of rent and other economic lease terms). The other option under the new standard is a slight variation on the 1996 standard maintaining differing load factors on each floor. While the measurement of individual floors will vary under either method under the new standard, the total rentable area of the building will be the same. Below is a brief discussion of the drivers behind the change, the nature of the change, and what tenants (including those considering renewal) should be thinking of to safeguard their interests. Keep in mind that this is a voluntary standard and it will be up to the commercial real estate industry to see how it is received and adopted.
Taking advantage of the depressed office market, as a savvy tenant you just renegotiated your office lease reducing your rent and locking in a low rent structure for the next several years. But did you close a big loop hole that could negate this great deal? If your lease is like most leases, it contains a subordination clause making your lease inferior in position to any existing or future lenders. In many states where a lease is subordinate to a mortgage and the lender forecloses on the property, the tenant is at the lender’s mercy as the lender can elect to terminate or recognize the lease. In such an event, the subordinate tenant is in a very vulnerable position as the lender has leverage to force the tenant to renegotiate the lease on the lender’s terms. To plug this loophole, a tenant should have a Nondisturbance provision in its lease and have a Nondisturbance Agreement with the existing and future lender(s). In today’s market, tenants are well advised to preserve some negotiating capital for this important issue.
The December 13, 2010 Wall Street Journal has an interesting article entitled “Downtowns Get a Fresh Lease: Suburbs Lose Office Workers to Business Districts, Reversing a Post-War Trend” by Anton Troianovski. The article summarizes a trend that we have seen across the country in office markets over the past few years where downtown markets have drawn more tenants than the suburban markets. This is largely due to a difference in tenant demographics between suburban and downtown markets in today’s economy. Specifically, many suburban office tenants are directly or indirectly involved with the housing industry where we have seen the largest job losses. Whereas downtown tenants are government entities, banks, financial services companies, law firms and professional service companies. This trend is also being driven by the redevelopment of many downtown areas around the country.
Today’s office market presents unprecedented opportunities for tenants. At the same time, tenants face risks that were uncommon a few years ago related to the financial well being of landlords. With some of the biggest names in the industry struggling, savvy tenants are extending their due diligence to the financial strength of their current and prospective landlords. Unlike a real estate sales transaction where the parties go their separate ways after the transaction is finalized, tenants must keep in mind that a lease is a long term business relationship. As this business relationship in most cases is vital to the operation of a tenant’s business, tenants must thoroughly vet their landlords.
Responding to the need for greater transparency in financial markets in the post-Enron era, a new accounting standard is being presented requiring tenants (both public and private companies) to recognize the current and future value of all leases on their balance sheets. This standard is jointly presented by FASB (Financial Accounting Standards Board) and IASB (International Accounting Standard Board). The proposed standard, if enacted, will be a factor in the real estate decision-making process for all companies. It will have a major impact on financial statements of companies with large lease obligations which are currently considered “Operating Leases”. While this proposed standard applies well beyond the lease of real property, my focus is on its impact to tenants in office leasing. It has been reported that this change will result in between $1 and $2 Trillion being transferred to companies’ Balance Sheets. Some question the timing of this proposed change given the economic conditions and the state of the commercial real estate industry.
All forward thinking tenants should review with their real estate advisor how the proposed standard will impact their real estate strategy. Below is a summary of the current accounting standard, the proposed new standard and its impact on office tenants.