Consider some common commercial lease pitfalls that have befallen many practice owners in their quest for a “good deal.”
I know the satisfaction of do-it-yourself projects well. I recently went online to purchase a new garage door opener, reasoning that I would be saving $15 plus whatever installation fees I’d pocket by putting it in myself. Now that I have installed it, I have a garage door that will only open half-way. I thought that my “savings” would help my case to buy the new convertible I’ve been eyeing, but it does little to please my wife who now has to park her SUV outside. The lesson learned: I should take on the tasks that are within my capabilities and let the professionals handle the rest.
While I would argue that installing a garage door opener is a fairly simple task, I would not say the same about installing a new kitchen. I would also contend that buying or selling a business is something that is best managed through the counsel of a professional, and the same can be said of negotiating or renegotiating an office lease. However, many in the market seem to think otherwise.
What many dentists find in their attempt to save a little money up front is that they lose much in the end. They sign contracts that they don’t understand and then have to suffer the consequences. Usually, according to them, until a leasing issue arises or a bill for “Additional Rent” arrives, most practice owners don’t think twice about negotiating their own leases. So why is this worth your time and consideration? Well, in most cases, real estate is a practice’s second largest cost behind personnel. It’s a big deal! To avoid a hard lesson of your own, consider some common pitfalls that have befallen many business owners in their quest for a “good deal.”
1. Weighing short-term needs only:
Lease terms can be one, three, five, 10 years or more. You will almost certainly get a better rate and more substantial concessions with a longer term deal, but it takes a little foresight. How does your practice look historically? What does this year look like? Do you have any specific contracts with hard renewal dates that need to be considered? How do you anticipate your headcount and space needs to fluctuate over the course of the lease term? Practices often only look clearly at today’s picture and plan poorly for the years ahead.
2. Foregoing an attorney’s advisement:
Ignorance is bliss. It is very easy to review a lease on your own and say “good enough.” Sometimes it is, but sometimes a major issue arises in the building. Consulting a licensed attorney during lease negotiations can help you ask the important questions before the bad things happen: How are capital expenses allocated? What is your exposure? How are your assets protected? Spending a little money now can save you exponentially down the road. Already have an attorney? Make sure they specialize in or have extensive knowledge of real estate law.
3. Leaving concessions on the table:
Price is the focal point for most companies in a negotiation. However, there are many other pieces to consider in the puzzle. Free rent, growth options, termination options, project management and moving allowances are other ways, when deployed in the right manner, that are just as important to the company’s future as that of strictly considering the price of rent. Tenant improvements are often the biggest factor that negotiations revolve around which can make or break a deal. If done improperly, these improvements can drain a dentist’s time, energy and money, all of which take away the focus of the business.
4. Creating unnecessary exposure:
Landlords typically want some sort of security to ensure that the lessee has some skin in the game. They might ask for verification in the form of security deposits, lines of credit, or personal guaranties. These are reasonable requests, but they are often negotiable. If it is a personal guaranty, is it for the entire lease obligation or does it burn off throughout the lease term? Also, if your firm has strong national credit, could you get away with providing a lot less? Another area of potential exposure is responsibility for upkeep of the facility – HVAC, roof, etc. Who pays for a new A/C unit if it goes out? Who pays for window glass if it gets broken? Don’t forget about the lesson learned from pitfall number two!
5. Painting yourself into a corner:
Time is money. By far the number one mistake made by companies is not allowing enough time for the real estate search and negotiation process. If you’re not starting the conversation six months ahead of a lease expiration, you’ve already started painting. Depending on the size of your practice, 12-24 months might be the right time to start. Doing so allows a quality negotiation and the positioning for alternate options. If you don’t have time, you don’t have leverage.
6. Realizing total occupancy costs:
Know the bottom line. In this part of the country, commercial real estate rates are quoted on a per-square-foot per year basis. Have you figured out the total dollar amount for the footprint you want to occupy? How does your rent schedule look throughout the course of your lease – escalations that can appear small when quoted per square foot can be quite substantial when figured out in actual terms. How are operating expenses passed through? Which ones are considered controllable expenses and is there a cap on those? When comparing options, don’t forget to factor in parking, as it can add as much as $3/SF onto your rental rate.
7. Lack of representation:
Tackling the real estate search and negotiation process takes time and market knowledge. Dentists that attempt to save money by doing it alone can be doing themselves a real disservice. How can you know that you are considering all of the options in the marketplace? How do you know that the rate and terms you are negotiating are in line with the market? How much time is the process eating away from running your main business? Most importantly, the landlord will have a listing agent representing their interests; shouldn’t you have someone represent yours? Landlords expect to pay broker commissions; they have them built into lease rates. A skilled professional real estate broker uses his or her market expertise to negotiate a deal that far exceeds their fee, which is paid for by the landlord, not the tenant.
8. Other incentives:
The grass can sometimes look greener elsewhere. If you are looking at cities, states or jurisdictions outside of where you are currently located or familiar, there very well could be economic incentives from those areas. Not sure where to start? Find out who heads the local Economic Development Council (EDC) and meet with them. Tax rate reduction can be a benefit, though often making the acquaintance of these individuals can provide a bigger value by helping you get city approvals and permits for improvements expedited through their system.
9. Knowing what good credit can do:
Better credit equals a better deal. Landlords look at prospective tenants as pieces of their investment puzzle. They will look at your practice’s financial strength and likelihood of paying the lease when deciding how many tenant improvements and concessions they will give you. Have your financials in order and be prepared to provide them. If you have a national presence, having the national credit and your corporate HQ sign a lease adds a tremendous amount of clout to your position.
10. Not realizing efficiencies in design:
As mentioned before, lease rates are calculated on a per-square-foot basis. You can increase your efficiency and decrease your monthly expense by a properly configured space with the appropriate department adjacencies. It makes sense to get an architect involved in space planning as you are negotiating to save you from accepting too large of a space. Additionally, consider productivity outside of the office building. Do you have to walk several blocks from your car and then change elevators to get to your office? Is there a better location that will save you and your employees some hassle and increase efficiency?
11. Paying too much rent:
Yes, this should be Top TEN Pitfalls, but we can’t overlook the obvious one right? You would be surprised. In a down economy, rental rates come down. Your landlord might lower your rate minimally and make you feel like you are getting a great deal, that is unless you knew that they were quoting even less to other interested parties in the market. Your representation would sniff that out in a hurry and advise you whether what is on the table is reasonable or not.
Tanner Mason is a Denver-based commercial real estate tenant and buyer broker. He is co-founder and Managing Broker at Benchmark Commercial and can be reached at email@example.com or 303.395.0111