Fire
Tenants are eager to get the space they think they need, so they start by looking around. Landlords market their buildings well and say what they need to say to get tenants interested. Tenants focus on what they know–like rental rate, lease term and “turnkey” buildouts–while landlords leave the important costs and risks out of sight and out of mind. Tenants, in turn, sign letters of intent based on vague terms, psychologically commit to the space and lose leverage to negotiate anything beyond page 1 of their leases.

The tenant was never ready and didn’t have the expertise to aim, but they fired. And now, they have a lease representing their second largest expense and possibly their biggest liability.

Ready
Following the lease, tenants may have to “negotiate” what is to be included in their buildouts, under what conditions they may perform subsequent alterations or sublet, or how to avoid getting overcharged on operating expenses. Tenants find themselves lacking leverage, because none of the above was properly evaluated or negotiated long before a lease (or renewal amendment) was drafted. The building services may also be deficient, partially because the building was not well-evaluated, but also because the lease didn’t protect the tenant.

Aim
Was the tenant’s space ever properly programmed? Were all operational needs relating to the space and building identified? How well does the overall financial structure of the transaction align with the tenant’s financials and business plan? Were potential business plan changes accounted for in the lease? Does the facility align well with the tenant’s organizational culture? Each of the above questions must be answered to avoid taking on undue risk or overcharge.

Of course, the right approach is:

- Defining the existing lease/expense situation and aligning your real estate plan to meet your strategic, operational, cultural and financial priorities (ready);

- Evaluating the facility, building infrastructure and landlord long before you ever get to a lease (aim);

- Implementing the lease, or renewal, to ensure that it comports with the lease terms you thoroughly negotiated at the proposal stage and effectively managing the design, construction and relocation, whether its performed by you or the landlord (fire).

Here are a few questions to ask yourself to gauge whether or not you can calculate your true lease costs:

-What method of measurement was used to calculate the rentable square footage you’re paying on and was that measurement confirmed?
-When you receive your annual operating expense reconciliation statement from your landlord, do the charges comport with your lease and are they in-line with market?
-Does the landlord have the right to require you to restore alterations, and how much will restoration cost you?
-How much in fees and “profit” splits will you incur to sublease?
-If you try to sublease a portion of your facility, can the landlord terminate your lease?
-How much will landlord oversight fees or a performance bond cost you to make changes to your facility?
-Can the landlord relocate you and what costs would you face if you had to move?
-What are the landlord’s obligations regarding the existing conditions of the premises, code requirements and who’s responsible for hazardous materials?

In short, for tenants, real estate is a process, not a commodity. Tenants who focus in on the rental rate while not professionally evaluating the other factors impacting their upfront and long-term costs and liabilities at the appropriate times expose their organization to unforeseen costs. By following the right process, tenants can minimize their true costs of occupancy and rest assured that they are protected from undue complications.

Mike Norris, LEED AP, a Vice President with the Washington, DC-based Ezra Company, one of the leading commercial real estate firms in the nation that exclusively represents tenants, negotiated on behalf of HyperV in an 8,800-square-foot lease of office, R&D and conditioned warehouse space at 13935 Willard Road, a 46,000-square-foot industrial building owned by Kol-Bio Medical, in Chantilly.

In addition to saving money, HyperV will also enjoy a stronger lease with greater flexibility. Doug Witherspoon, HyperV’s CEO, spoke about the importance of having built-in flexibility negotiated into the lease, especially during these uncertain times:

“Mike negotiated a termination clause that takes effect after the first year of our renewal, so we will know exactly what it will cost, if our needs change.”

Privately-held HyperV, which Witherspoon founded in 2004 in his basement, first established itself at 13935 Willard Road about six years ago, when it leased 4,400 square feet. Then, three years ago, the company expanded to 8,800 square feet. The most recent lease contains expansion and renewal options, among several other key provisions that Norris, who has represented HyperV since its inception, was able to negotiate.

Witherspoon also offered some advice for other companies facing a pending lease decision. “Make sure you have a really good tenant representative. I’m a scientist; the ins and outs of leases, to a large extent, seem Greek to me. I’ve got to rely on Mike to explain what clauses mean to me. Without Mike, we would be lost.”

Currently, HyperV is developing advanced plasma gun technology with applications in industry, fusion energy and plasma physics research. This technology will support research in several approaches to fusion energy development and has a variety of near term industrial applications.

Besides its practical purpose this time of year, it’s the best metaphor I can make for tenant representation. It must be applied thoroughly and repeatedly to be effective. When getting involved with a facility or lease, tenants generally think to cover themselves in the most obvious areas like the rental rate and general buildout needs, but they don’t think about the scores of other areas that they leave unprotected. Here are just a few of the areas tenants leave themselves unprotected:

PREMISES
1. Use of Premises
2. Warranty of Use
3. Common Building Facilities
4. Measurement of Office Building Premises
5. Usable Area
6. Rentable Area
TERM
7. Defining the Term
8. Existing Premises
9. Early Occupancy
10. Landlord’s Failure to Deliver Possession
11. Holding Over
RENTAL RATE
12. Base Rental
13. Fixed Rent
14. Free Rent
15. Cost of Living Adjustments
16. Direct Metering, Sub-metering,
and Electric Rent Inclusion
OPERATING EXPENSES & TAXES
17. Operating Expense Escalations
18. “Grossing Up” Operating Expenses
19. Operating Expenses / Capital Expenditures
20. Operating Expense Exclusions
21. Operating Expense Audit
22. Management Fees
23. Taxes and Assessments
24. Real Estate Tax Exclusions
CONSTRUCTION
25. Substantial Completion
26. “As-Is” Condition
27. Tenant Move-In
28. Tenant Delays; Excusable Delays
29. Long Lead Item
30. Punch-List Penalty
31. Removal
32. Holding Over / Construction Delay
33. Landlord Allowances
34. Construction Drop Dead Date
35. Construction Schedule
36. Workletters
37. Building Standard Specifications
38. ADA Compliance – Premises
39. ADA Compliance – Building
40. Code Issues, Fire & Life Safety, Sprinklers
41. Completion of New Office Premises
OPTIONS
42. Right of First Offering to Lease
Additional Space
43. Right of First Refusal to Lease
Additional Space
44. Options to Purchase
45. Right of First Refusal to Purchase
46. Option to Contract
47. Option to Extend or Renew a Lease
48. Termination Options
CONDITIONS OF PREMISES
49. Alterations
50. Landlord’s Inspection of Premises
51. Damage and Destruction
52. Damage to Premises
53. Landlord Agrees to Repairs
54. Mechanics’ Liens
55. Surrender
56. Early Termination of Lease
57. Redelivery at End of Term
58. Fixtures
SUBLEASING & ASSIGN
59. Provisions for Assignments
and Subleases
60. Consent Standards
61. Redefining the Assignment and Sublease
62. Recapture and Profit Sharing
63. Sublet to Affiliate
LANDLORD SERVICES
64. Rules and Regulations
65. Landlord’s Services
66. Common Areas
67. Electrical Usage
68. Utilities
69. Landlord Failure to Furnish Services
70. After Hours Services
71. Chilled Water for Supplemental AC
72. Repairs and Maintenance
ENVIRONMENTAL COMPLIANCE
73. Landlord’s Warranty of Compliance
74. Compliance with Environmental Law
75. Air Quality (ASHRAE)
76. Temperature Specification
77. Landlord Hazardous Material
Representation, Warranty and
Indemnification
INSURANCE
78. Landlord Insurance
79. Tenant’s Insurance
80. Insurance Increase due to Tenant
81. Indemnification
82. Liability Insurance
83. Property Insurance
84. Waiver of Subrogation
DEFAULT
85. Events of Default
86. Tenant’s Cure Rights
87. Tenant Default Notice
88. Late Charges
89. Landlord Mitigation of Default
90. Default by Landlord and Tenant’s Remedies
91. Landlord’s Lien
LEGAL SECURITY
92. Security Deposits
93. Letters of Credit
94. Joint and Several Liability
95. Personal Liability Elimination
CONDEMNATION
96. Condemnation and Eminent Domain
97. Total Taking
98. Partial Taking
99. Temporary Taking
100. Landlord’s Restoration of Premises
101. Allocation of Condemnation Award
INDEMNIFICATION
102. Waiver and Release
103. Mutual Indemnification
104. Landlord Indemnification
105. Landlord Negligence
GENERAL PROVISIONS
106. Access Provisions
107. Subordination/Non-Disturbance
108. Arbitration
109. Submission of the Lease
110. Lease Execution Drop Dead Date
111. Time is of the Essence
112. Consents and Approvals
113. Estoppel Certification
114. Notices
115. Attorney’s Fees
116. Waiver of Jury Trial
117. Representation and Warranties by
Landlord
118. Equipment Allowed in the Premises
119. Consent and Approval
120. Signs
121. Covenant of Quiet Enjoyment
122. Succeeding Party to Landlord
123. Force Majeure
124. Building and Premises Security
Management Weekly
125. Parking

Before you engage with landlords over what you may believe to be a simple lease or renewal, think about all of the areas that you need to cover. Are you protected? Don’t get burned by landlords.

Understand that real estate is a process

From professionally defining the requirement to evaluating the facility to negotiating the right deal structure, there are a myriad of factors that go into what may be a year-long tenant representation process. Tenants do not devote such extensive allocations of their staff’s time to our process for a deal to unnecessarily fall apart at lease.  A good attorney will understand the lengthy context of the project, draw upon their experience to recognize what is achievable given the circumstances and work with the tenant representative to assist in providing additional lease protections.

Leave deal terms to the professionals

There are numerous factors impacting the economic terms of a lease, including existing conditions, code issues, base building obligations, the value of options, the credit of the tenant, the landlord’s investment strategy and underlying market conditions.  There’s no way for an attorney that isn’t evaluating scores of facilities and leases each year to assess the economic terms of a particular lease, nor does an attorney have the expertise or market buying power to negotiate such terms.  The best attorneys bring in a professional tenant representative to manage the process for the tenant and focus on ways to strengthen the resulting lease or amendment based on new legal precedent or the tenant’s specific business characteristics.

Accept the review as a loss leader

A lease review (inclusive of the time necessary to grasp the project and participate in any subsequent discussions) usually only consumes a handful of billable hours.  A good attorney will turn around any suggestions to a tenant representative’s comments within days and be available (or make a colleague available) for any necessary conference calls within short notice.  Time kills deals, and losing the right deal can cost a tenant considerably.   

Striking the right balance is important when selecting an attorney for a lease review.  You have the potential of gaining some valuable protection without spending a lot of money, but you can also end up spending excessively and losing a facility important to your business.  Your real estate is typically your second largest expense behind your people, so while the lease review is typically a minor expense, choosing who to conduct it requires careful consideration.

As the chart demonstrates, landlords are simply a larger source of revenue than tenants for firms that represent both. The revenue discrepancy results from not only the larger amount of space (which the fees are calculated upon) that a landlord owns (compared to the amount of space that a tenant leases), but also the broader array of services that landlords buy.

Now imagine how this chart would look if your landlord (or a landlord of a building that you’re considering) has a large local or national portfolio of buildings; the fee potential from the landlord side compounds several-fold, while the revenue potential from the tenant side remains the same.

Most tenants are in tune to the conflict of interest that exists if the firm they hire is also representing the landlord of their building (also known as dual agency), but many tenants do not see the hidden conflict of interest that exists when the tenant’s representative is pursuing listings from that landlord elsewhere. For example, I was recently chatting with one of my colleagues and each of us recalled being told, at a couple of our prior firms that represented both landlords and tenants, that we should keep in mind while negotiating for our tenant clients that the firm is pursuing listings with certain landlords.

Here are a few steps you can take to uncover any potential conflicts:

-Ask your representative for a complete list of his firm’s listings as well as their asset/property management and construction management work with your existing landlord and with any landlords in your target market, locally or nationally.

-Ask your representative if he will agree, in writing, that his firm will not to pursue any listings, property/asset management or construction management work with any landlord under consideration, locally or nationally.

There are several good listing, asset/property management, and development firms in our market and across the country with which we have a strong working relationship. However, it’s important to understand from where each firm derives its revenue and to avoid conflicts of interest that can cost your company money and result in you taking on undue risk.

-Preparing your facility and leases for a merger or acquisition.
-Why an attorney is a supplement, not a replacement.
-What to do when you receive a notice from your landlord.

In the meantime, below is a summary of the critical facility and leasing topics we have covered that may be impacting you now or in the near future.

Overcharges on Operating Expense Passthroughs

Negotiating Directly with the Landlord

Expansion Done Right

Why Landlord Let Space Remain Vacant

The Right Time to Start the Process

Knowing the Types of Landlords

Strategic Decision to do Nothing

Avoid Being Stuck in Your Existing Lease

The Path of Least Resistence vs. Risk Mitigation

Just Want to Renew? It’s Not That Easy

Here are just a few of the issues that you may encounter:

IT: How is the space wired, and where is it wired to? What access will you have, and what access will the sublandlord have? How secure is it? What happens if either the infrastructure or service fails? Who’s responsible for restoration?

Approval: Don’t forget that you’re not just dealing with the person from whom you’ll be subleasing space; you’re also dealing with their landlord and possibly that landlord’s mortgagee. Do you know the criteria for consent? Even if you meet the criteria, the landlord may still reject the sublease, delay it for weeks/months or burden it with conditions. Many people don’t realize that the building owner is typically predisposed against subtenants, as they usually don’t make the owner any more money, drain building services and don’t stay after the sublease term.

Service Interruption: What happens if a building system or service fails and you can’t use the space? The landlord is not responsible, and you have no protection since you don’t have your own lease. You will need alternative remedies.

Subordination: What if the building owner defaults with its lender or servicer and the building gets taken back? Your sublease, like the prime lease, is subordinate to the lien of that lender or servicer. How are you protected from foreclosure or other termination of the prime lease?

Default: How are you protected against the sublandlord’s default? The landlord does not have to (and usually does not) allow you to continue to occupy the space, irrespective of what a disruption and move may cost you.

As always, the right real estate solution needs to be derived from the tenant representation process. Don’t be fooled by the appeal of ostensibly quick, easy and cheap space. We may end up concluding that subleasing is the best solution; but if we follow the process, we will successfully negotiate the potential risks to ensure that the benefits of subleasing are fully enjoyed.

After most companies sign a lease, it goes in a drawer somewhere for the next several years. In some cases, the lease or renewal was well-negotiated; a tenant representative was engaged to properly determine needs, thoroughly evaluate options, leverage the market and work in concert with your attorney to negotiate every aspect of the lease. Here’s the problem: your lease is only as strong as your ability and willingness to enforce it.

One of the most common ways companies get overcharged by virtue of not enforcing their lease is operating expense passthroughs. A year or so after you sign the lease, you start getting bills from the landlord for projected increases to building operating expenses, such as maintenance, snow removal, landscaping, insurance, utilities and various building repairs. How much time do you spend with those statements? Around the beginning of each subsequent year, you’ll get a reconciliation statement showing the difference between what the landlord budgeted and what the landlord actually spent. Spend a lot of time on that statement? Do you tap into your extensive database of nearby buildings to compare expenses to make sure they are within the arms-length competitive market? Do you compare your operating expense exclusions in your well-negotiated lease with those for which the landlord is charging you? Of course not–you have a business to run.

That’s where we come in. Over the past three years, the Ezra finance team has saved clients (and prospective clients) $11 million in erroneous operating expense passthroughs. The team has been conducting these reviews for over 15 years and discovers errors over 70% of the time. So how do we get the erroneous charges removed/refunded? Sometimes, the landlords will acknowledge the error and cooperate. Other times, our buying power in the market helps; we complete 2 million square feet of transactions each year and have been in business for 30 years. As a landlord, you don’t want us to view you as a landlord that overcharges our clients. Here’s the best part. Of the $11 million our finance team has saved clients in the last 3 years, $11 million was returned to the client; in other words, we don’t charge for the service, because over 90% of companies that use the service engage us to handle their leases when the time is right and we take pride in enforcing the leases that we work hard to negotiate.

So how do you know that you’re not being overcharged? Send me your reconciliation statement when you receive it over the next several weeks along with your lease, if I don’t already have it. Those documents will get us started on our confidential, no-cost and no-obligation review.

CEO Roundtable Reminder

Less than one week away. A few spots remain.

If you’re an executive entrepreneur or know of one that should attend this roundtable, just let me know, and I’ll take care of registration. Just two weeks left to register and few spots remain. Everyone else can register for the networking reception here: Event Registration

When:
Tuesday, January 25, 2011

CEO Roundtable: 4:00 – 5:30
Networking Reception: 5:00 – 7:00

Where:
Teqcorner
1616 Anderson Road
McLean, VA 22102

Roundtable Discussion:
Are you preparing to renew, renegotiate or enter into a new office/warehouse lease?

If you’re a growing company facing a real estate decision, you’ll want to attend this executive only seminar. Topics will include:

• Stuck in an existing lease?
• Should you rent or buy?
• What type of space fits your business?
• How does pricing work? What are the hidden costs?
• How do you avoid being overcharged?

Whether you have a facility or are contemplating your first, there are several actions you should take to keep your costs low and your risks minimal. In today’s economy, you cannot wait until you “need space” or “need to renew” to plan for your next facility lease. Your existing facility, lease and business drivers should be regularly evaluated against the ongoing changes of the landlord, lender and market. Your real estate is a process, not a commodity. This discussion will enable you to properly prepare, while hearing from entrepreneurs who have done it right!

Please contact me at mnorris@ezracompany.com or (240) 497-8210 with any questions.