Newsletter Follow Through: Typical Areas of Dispute of an Office Lease

November 2 So, here are some typical areas of dispute regarding office leases:

  • Inclusion of certain expense and tax pass-throughs-increased building operating costs are shifted or “passed through” to the tenant.  However, most leases do not allow the pass-through for tenant-procurement costs, financing and ownership costs, building depreciation, or capital improvements.
  • Establishment of an under-reported base year-the rent stated on the lease supposedly reflects the full costs of operating and managing the building at the beginning of the lease year, or the “base year.”  In case of inflation, the lease will also include an operating expense escalation clause, which dictates that the tenant will pay the levels of cost increased over the base year amount.  However, the rent for the base year might have been under-reported due to existing warranties and building vacancies.  Landlords might also low-ball the base year to attract tenants.

Other common areas of dispute can include space issues and miscalculation of electricity fees.  The landlord might discreetly make a profit at your expense by purchasing electricity in bulk and reselling it at market price.  Having a professional, exclusive tenant broker negotiate the lease can help head off many of these problems.

Now that we have discussed the areas covered by lease audits, when is the best time to have one?  Here are 4 occasions:

  • A base year audit is the most important audit.  For a net lease, the base year audit would be done for the first lease year, since the tenant is responsible for paying its pro-rata share of all expenses starting on day 1 of the lease.  This audit establishes the proper expense level against which all future year’s expenses will be measured, while documenting the landlord’s methodologies for calculating the base-year expenses.  This compels the landlord to determine expenses on an “apple to apple” basis.  For a gross lease, audit should be performed the first year that the tenant is responsible for operating expenses or tax escalations.
  • If the building ownership has changed hands, consider an audit.  New owners look to improve margins-often at the expense of the tenants.
  • In the final year or two of its lease, an audit may provide not only financial reimbursement, but leverage for negotiating a lease extension.
  • If the expenses rise beyond what appears reasonable, an audit may be appropriate.  Review the year-to-year increases in specific expenses before doing an audit.  If expenses rise sharply year-to-year due mostly to increased utility costs, an audit is probably not necessary.

Federal Reserve: Texas factory output falls

(Houston Business Journal) -A sense of stabilization that hit the Texas manufacturing sector in September has been dampened by a new report from the Federal Reserve Bank of Dallas, which shows the state’s factory production index fell deeper into negative territory during October.

The Fed’s Texas Manufacturing Outlook Survey said the production index — which measures manufacturing activity — contracted in October even after remaining stable throughout September.

The Lone Star state produces at least 8 percent of the United States’ total manufactured goods, ranking behind California in production.

The report concluded that business activity indexes were “slightly negative” and many executives still reported “no changes” from September.

Selling prices remained consistent between September and October, while the raw materials price index rose with companies saying they’re dealing with higher input prices.

Many manufacturers are still seeing net price declines on their goods, the report added.

Measures of activity that improved in October include the future indexes for capacity utilization. In addition, shipments reached their highest level in 26 months, the report said. The six-month production index also was positive in October.

Weekly Review / October 19-23

~Llenrock & Lowery Blogs

Houston’s pace of layoffs slows

(Houston Chronicle) – Houston is losing fewer jobs than it was earlier this year, according to data released by the Texas Workforce Commission.

Houston area employers trimmed 76,700 jobs from their payrolls between September 2008 and September 2009. That represents a 3 percent year-over-year decrease.

University of Houston economist Barton Smith estimates the Houston area lost between 6,000 and 8,000 jobs in September, with about one-quarter of those jobs in accommodations and food service. Until recently, he said, that sector had been holding up fairly well.

While that sounds like a lot of jobs, it is only about half as much as the 15,000 jobs Houston employers were cutting each month during the spring, said Smith.

“Unambiguously we are still losing jobs in Houston, Texas,” said Smith. “But we have enough data to show the rate of loss is declining.”

10 Golden Rules of Office Moving

On average companies only move office every 7 years and the vast majority of people assigned to manage the move are doing so for the first time. There are so many things to consider when you move office. At the same time you have to continue to run your business and focus on your existing workload and commitments. No wonder moving is ranked as one of life’s most stressful events. So, for most companies, the prospect of moving office is a daunting process. But like any process it can be broken down into a series of simple tasks and checks. By following these Golden Rules you can ensure your office move is on time, to budget and hassle free.

1. Assess your needs and current situation

You need to be clear about the purpose of your office relocation, (e.g. lease break, lease expiry, planned growth or contraction), in order to define your needs and map out the appropriate office move plan. There are some big decisions that must be agreed as the starting point and which will form the basis of the subsequent planning process including the details of the existing lease and notice period and your current obligations and liabilities.

2. Be clear about your requirements

A clear understanding at the outset of your basic strategic and operational requirements will make the whole moving office process go more smoothly – and save time. Don’t worry too much about the technical specifics (as that is part of the advice given by the external property move professionals), however, you must have an overall idea and consensus from the decision makers about the key drivers of the office move including:

* Where you want to move to * How much space you need * When you need to be in by * What key features you need your new office to have * What your planned business objectives (including growth plan) the move needs to satisfy * Type and length of lease you want

3. Build the right office move project team

An office move is a major undertaking and a collaborative effort is needed for a successful outcome. Putting together the right project team is critical and should include people who will help facilitate all aspects of the move. It will need to comprise both internal and external members. A Project Leader must be put in charge of the move process as soon as the decision to move office has been made. This person must have enough time to devote to the office move project and should: have the trust of senior management; the authority to act on behalf of the company; be senior enough to be able to make decisions; be a good organiser of people and processes; have experience of setting and working within budgets; and be a good communicator.

4. Start early

There’s a lot to do, so the earlier you start the greater the chance of achieving the smooth move your company expects. It is impossible to plan too far ahead. Once the Office Move Project Leader has been appointed work should start. You should start reviewing your options 9 – 18 months prior to your lease expiration regardless of whether you are considering renewing, renegotiation or relocation. It is vital that you allow enough lead-time to increase the amount of leverage and competition between the various options, which can result in substantial savings for you.

5. Create a realistic budget

Creating a realistic office move budget is a critical planning tool that will help you assess your costs and manage them throughout the process.

6. Engage the right office move professionals

The whole moving office process can be complex, stressful and time-consuming. After people costs property costs are most company’s next biggest expenditure. The decisions you make will have an impact on your company’s profitability. Working with the right professional team is the single biggest must-do for any company thinking of moving office. They will guide you through the process, save you money in the long run and also make sure you don’t make any critical mistakes.

7. Don’t sign any lease documents without getting legal advice

Your property solicitor will negotiate the detail of the lease documentation to minimise your exposure to potential liabilities, and subsequently, to advise you on the implications of the detailed terms in the final documents to ensure you are aware of your ongoing responsibilities.

8. Communication

Internally, change can be unsettling for staff and this can certainly be the case with an office move. At the same time as the office move process is going on, your company has to continue to run its business and focus on its existing workload and commitments. However, moving office is a great opportunity to affect positive change management, improvement in business performance, increased morale and momentum. Externally, there are many moving parts to an office move and you need to ensure that everyone involved in the project is regularly updated, especially if there are any changes. If you keep the lines of communication open to all interested parties, internal and external, your office move will have a much greater chance of success.

9. It’s a process

The prospect of moving office may seem a daunting process but like any process it can be broken down into a series of simple tasks and checks. The intelligent use of your project planning documents, spreadsheets and checklists will not only help you plan the office move, but also act as your road map to carry out the many tasks involved with the project. Don’t try and reinvent the wheel when you can use tried and tested moving office tools and guides.

10. Take advantage of the opportunity

Clear out old files and purge all storage areas of unneeded items prior to moving. Also consider scanning any documents no longer needed in hard copy (remember to dispose of unwanted files securely). Secure storage and/or archiving of documentation is a flexible, safe and cost-effective solution to free up valuable and more costly office space. It can be accessed at any time by arrangement and provides excellent off-site backup for damage limitation in case of fire or other disaster.

* Upgrading – Moving office is an opportunity to update to modern, efficient and space-saving equipment. * Review existing suppliers – Moving office can provide a trigger for renewing/switching supplier contracts on favourable terms. * Don’t forget your customers – Moving office is a great opportunity to communicate positive messages to your customers and maximise the brand and image of your business.

Weekly Rewind: October 12-16

~Llenrock & Lowery Blogs

Required Reading

Leasing Office Space You Can Afford : Everything Companies Need to Know-From Finding Great Space, and Negotiating the Lease, to Moving in

Robert J. Cook

red-book-white-background This is an excellent college level text book that is (for a change) written by a real world practitioner. I have used the book in college courses I teach in real estate investments and management and find it excellent.

I recommend the book to my leasing associates and tell them to “Emerse” themselves in its contents so they will understand the language and methodology of leasing office space.

Great guide to anyone wanting to get started in office leasing.

8 Ways to save money on an office lease

1. Don’t pay for space you can’t use. All square feet are not created equal. Have the landlord pay for a “space plan” to determine your “load factor.” (Also sometimes referred to as a “loss factor.”) This is the ratio between the non-usable and usable square feet that your rent will cover. Examples of non-usable square feet would be building common areas, such as corridors, or a lobby. Typically, office space load factors are in the range of 20 percent to 30 percent, meaning for 1,000 square feet of usable office space, you might pay for 1,200 square feet. Landlords like high load factors because they pad the bottom line. In a market like this, however, they need to secure tenants, so you have more leverage than normal. Negotiate the load factor down to at least 15 percent.

2. Beware of free rent.
Structure the rent so that you phase into the space. Pay for half the space during the first six months of the lease, the full space at seven months. If you get “three months free,” be sure the landlord has not extended your lease term on the back end, to 39 months from 36, a common tactic.

3. Avoid standard improvement allowances. If the rental rate being offered includes a standard improvement allowance and you do not want or need to make improvements, then amortize this allowance out of your rent.

4. Cap operating expenses.
In most office buildings, operating expenses are included in your rent. They increase yearly, but you can put a cap on operating expense increases. A 5 percent cap is reasonable. It protects you from spikes in utility costs or increased property taxes if the building is reassessed. Also, retain the right to audit operating expenses.

5. Negotiate your renewal option in advance. Landlords like to include a commitment to renew up to one year before your lease is up. This forces you to address your real estate needs long before you’re ready. Negotiate the renewal down to six months by agreeing to a renewal rate equal to fair market value. Renewal rates are re-negotiated at re-signing anyway. The important thing is to move back the option deadline.

6. Negotiate holdover rent penalty in advance. Holdover rent occurs after your lease term has expired and, for whatever reason, you’re unable to vacate the space on time (usually when your pending move is delayed). Landlords will want double rent as a holdover. Negotiate this down to 125 percent of current rent.

7. Consider a buildout. If a landlord offers an allowance to build out a space to your specs, take the time to get a construction bid. Make the landlord pay for the estimate. Be sure the allowance can be used for architects, construction management, your moving expenses and data wiring. Most landlords draw the line at furniture and fixtures, but ask for it.

8. Demand right to sublease. Get it in the term sheet that you can sublease your space to anyone you wish for any amount of rent, subject to an approved use. Also, be certain that the landlord cannot impose any fees to your sublease. A common fee to avoid is a “document review fee” to cover the landlord’s attorney bill. Also, insist that the landlord turnaround sublease approvals quickly, within three to five business days. The last thing you want is to lose a subtenant to administrative delays. ~Rofo blog

U.S. executives say business conditions improving

(Reuters) – Top U.S. executives are becoming more hopeful about the global economy and the U.S. business outlook, according to a survey of business leaders released on Thursday.

More than 60 percent of corporate leaders surveyed by the Business Council in October now expect conditions in their own industry to improve over the next six months. In contrast, almost 90 percent of those surveyed in February said conditions were worsening.

The outlook is “better and improving, said James Dimon, Business Council vice chairman and JPMorgan Chase & Co (JPM.N) chief executive officer. “It’s a really dramatic swing.”

More than half of the Business Council members say they expect the global economy to continue to improve moderately during the next six months.

Still, worries about inflation prompted almost 46 percent of CEOs to say the U.S. government should begin to unwind its massive asset purchases to avoid inflationary pressures. In May, just 15 percent of respondents had supported the measure.

The Business Council is an association of about 120 CEOs from the largest U.S. companies. Members meet several times a year to discuss major business issues such as health care policy.

Some 70 percent of the survey respondents said they expected the retail sector to show continued moderate improvement.

“These results are encouraging, given that consumer confidence is rated the single most important factor in shaping the outlook for 2010,” according to the survey, which was compiled by the Conference Board.

CEOs said their ability to raise prices had improved. More than 53 percent said pricing power had stabilized and 26 percent said prices were rising.

Still, executives remain cautious about next year. The majority of Business Council members expect the U.S. economy to grow at a rate of 2 percent or less during the first half of 2010.

“We need to create an environment here that attracts investment,” said James Owens, chairman and CEO of Caterpillar Inc (CAT.N). “We’re going to need to make a transformation as an economy into one that saves more, invests more and exports more.”

Tenant Trade-Offs

Personal Guarantee:

If tenant does not want to give personal guarantee an alternative would be large security deposit, pre-paid rent, a UCC-1, or other collateral.

Tenant Rent Reduction:

If tenant wants a rent reduction 1st year, the tenant can offer a long term lease, escalations greater than the inflation rate, a large security deposit, or pay for TI.

Landlord to pay for improvements:

If tenant wants landlord to pay for improvements a trade-off would be higher rent or amortizing the cost + plus interest.

Negotiations hit stalemate:

If negotiations are at a stalemate, prepare a face to face, walk away, or call the competition.