Today, we take a closer look at how to get a meeting of the minds of tenants and landlords, who are, for good reasons, at odds with one another on the issue of lease renewal options.
In this post, we continue our conversation about the tricky topic of lease renewal options that we began a couple of months ago.
Missed part one? Catch up here.
So, how do we bridge this obvious gap in the benefit of options between the landlord and the tenant?
To be sure, current market conditions favor the landlord. Vacancy is under 1% in some submarkets.
So, a simple “no” from the landlord is often enough to end the discussion on options to renew leases.
But, all landlords are not alike. A private investor who owns a single freestanding building is quite different from an institutional player who is leasing space in a major business park. The hold and exit strategies for each investor type is altogether different. So, a tenant looking to negotiate an option to renew should know what type of investor owns the building they intend to lease.
The private investor holds an asset that may be worth more as a vacant building to an owner/user buyer rather than to another third-party investor/buyer who will capitalize rents to determine the property’s value. Thus, the granting of an option at a fixed price or via fair market value determination will tend to work against the owner, and resistance to the option is likely to be significant.
Having a firm understanding of the private investor’s long term plans for the building is critical. The longer term the hold strategy is, the better the chances are that a tenant could negotiate a favorable renewal option.
The institutional investor-owned business park, on the other hand, was built and is operated as a cash flow generator, and if sold, would likely be purchased by another institutional investor looking to do the same thing. So, the granting of an option based on fair market value carries less risk, as no owner can reasonably expect to achieve rents that are above market. Fixed price options are more problematic, as institutional owners are keen on taking advantage of strong rent growth in real estate upcycles like the one we are in now.
Major institutional owners often own multiple projects within a market and some offer their tenants the right to terminate existing leases if the tenant agrees to relocate within their portfolios.
In fact, the biggest institutional players use this alternative to renewal options as a marketing tool to attract tenants in high-growth sectors. The terms of these relocation options are specific to each tenant and depend on the landlord’s investment in improvements made on behalf of the tenant along with the size of the space involved in the relocation.
In the end, tenants pay a premium for this privilege, but it can be a less expensive alternative to being stuck in space that no longer suits their needs.
We will continue our conversation on this topic soon by taking a look at another potential solution to the option dilemma: options to terminate. Stay tuned.