Rent Is Rising, What Can You Do About It?

BY DAVID ALEXANDER
David Alexander Co.

We've all heard about Seattle area's rising rents, but what does it mean to you and what can you do about it?

It means that when renewing a two to four-year-old lease, you can expect to pay up to 40 percent more for the same space. It means that an office space that rented in January 1995 for $15.50 per square foot and included a tenant improvement allowance of $30 per square foot and a $1.50 moving allowance, today would cost $18.50 per square foot with only $15 in tenant improvements and no other concessions. It means that the landlords, often the lenders that took back buildings because they did not reach the developer's pro forma of $23 per square foot, will achieve those rents and possibly more.

Rent is the second largest cost companies incur, so with the projected increases, it is more important than ever for companies to review and manage their leases to maximize cost effectiveness.

The key is managing the lease. The initial negotiations are crucial and determine the terms of the agreement, but periodic attention to the lease and associated costs is essential to ensure the accuracy of expenses. Here are some simple steps you can take now to save money.

First, get organized. Have your lease file in a handy place. This may sound trivial, but a surprising number of tenants can't even find their original lease, let alone associated documents and landlord correspondence pertaining to the lease. Searching for documents is time consuming and can be costly.

A complete lease file should contain the following: the original lease, signed and notarized; space plans; all amendments to the lease, also signed and notarized; estoppel agreements; subleases and assignments; certificates of insurance; annual expense statements with details; correspondence to and from the landlord and related others; invoices and rent adjustment billings. Organize now and you will thank yourself later.

We also recommend clients keep an abstract of each lease in the file for easy reference. Abstracts give a quick summary of the terms, rents, and expenses of the lease. When kept up to date, they are especially valuable for preparing annual budgets.

Know the terms of your lease. Not only know the terms, but have critical dates in your calendar so that you are prepared. Also review the key terms of the lease including expiration date, how rent is calculated, how expenses are paid and increases are handled, when options occur and when you need to exercise your right to renew. Missing the exercise date of an option can mean paying substantially higher rent -- and that hurts. So, prepare in advance. Rest assured your landlord will.

Assess the lease performance. This is particularly important to businesses with multiple leases or those measuring performance against cost of space. There has been a great deal of emphasis on organizations reducing rentable square footage per employee and increasing sales in relation to rental expense. Know if you have the space you need, if it is suitably located and laid out, and if it is competitively priced. (Cross referencing industry standards specific to your business provides a basis for comparison.)

When you have assessed the lease performance, you will have much better vision in exercising options as well as renewal negotiations.

Talk to your landlord. Landlords are important to the success of your business. A good working relationship is not only common sense, it is a partnership where both parties profit. The key is proper balance. A good landlord is experienced, responsive and concerned about the long-term relationship with tenants. Good tenants maintain a position of trust and good faith. When you need something from the landlord -- and chances are you will -- you'll save money if you can work on the basis of long-established mutual respect.

Confirm your square footage measurement. Post-occupancy space measurement is a hot topic in commercial real estate today. While square footage is the common denominator of leasing there are subtle differences in interpretation by landlords and tenants.

The central issue in measurement conflicts is methodology. For years, the majority of commercial space has been measured from floor plans, typically prepared by the owner's architect. This can create two areas for error: human error from handling a ruler and calculator, and variance error that frequently exists between the square footage in the plans and that of the physical space.

The technology exists today to do precise measurements of actual physical space, and I foresee a time that space will be measured and certified to avoid any conflict. It is, after all, the only way to determine rent and the tenant's pro rata share of expenses. Until then, tenants that find discrepancies will be faced with how to negotiate a fair resolution, while maintaining a good, working relationship with the landlord.

Finally, check expense adjustments. Like balancing your checkbook, chances are when you audit expense adjustments you will find errors that will save you money. There are generally accepted accounting principles that govern allowable expenses in commercial leases, but it is the tenant's responsibility to check for accuracy. Be sure you have the right to review your landlord's books and ask for detailed expense statements that can be compared from year to year.

For example, if you negotiated limits on increases in operating adjustments, you may not be receiving them. Often in large, multi-tenanted developments, landlords will process expenses the same for everyone. Although it is a Herculean effort for the landlord to figure each expense statement separately, if you negotiated it, you need to make sure you are receiving it.

Or, if you have a gross lease in a building that is new or has been substantially vacant, the "gross up" provision in the lease may have been underestimated and you may be paying too much. The gross up provision enables the landlord to bill for expenses on a pro rata basis as if the building has been at least 95 percent occupied.

Most gross leases establish a base year threshold for operating expenses and as expenses increase you pay your pro rata share of the increase. What you as a tenant want to ensure is that the base year amount is as high as is reasonable. If the landlord underestimated this amount (and you can check by examining the landlord's assumptions) you may be able to recover some expense money.

We audited leases and expense charges for one of our clients, whose spaces total more than 85,000 square feet. We found a number of inadvertent errors in assessments resulting in the tenant's recovery of more than $125,000.

Your new expense statement will be arriving soon. Take time to thoroughly check it. Your dollars are in the details.

David Alexander started David Alexander Company in 1986 and specializes in corporate real estate services including long range planning, property transactions, lease administration and lease auditing.

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