If you’ve had to secure a new facility for your business in the last several years, you probably know just how difficult it can be to make happen. Business owners throughout Southern California have been struggling with the problem of short supply for more than 10 years, and the situation is not improving.
Vacancy has dropped to less than 2% in most submarkets and construction of new buildings is now limited to the Inland Empire where land is still available for industrial development.
One thing is sure: landlords have the upper hand in negotiations. Most insist on long-term leases, demand strong credit and have pages of comps that support a lease rate far above any you’ve ever seen. In fact, the pace of rent growth has accelerated throughout 2021 and looks to maintain its current trajectory into the coming year. Frankly, we’ve never seen anything like it and it’s getting so hard to predict a market rate that many properties are offered without an asking price.
With the foregoing in mind, it is clear that waiting until a few months before your existing lease expires to search for a new facility is a dangerous approach. Chances are, the space you are looking for will not be available in the time frame required. As the saying goes: extraordinary times call for extraordinary measures. So, we recommend a thorough reset of your strategy no matter how many years may still be remaining on your lease. There are workarounds to the problem, but it requires creativity, flexibility and a willingness to take action. This is something we can help you with and stand ready to do so.
Let’s take a look at a fictional situation that is typical of the predicament that many tenants find themselves in these days. A business owner, we will call him Bob, is operating out of a 40,000-square-foot building in Anaheim and he is in the 3rd year of a 5-year lease. He is paying $.83 per square foot after the latest fixed annual increase. His business has grown since he signed that lease and he now needs 70,000 square feet to accommodate the increased demand for his product. If he is like most tenants, Bob thinks he’s stuck in the facility until the lease expires, but resists looking for another short term space elsewhere because of the probable loss in efficiency. So, he maintains the status quo and misses the opportunity to grow the business.
What else can Bob do? He has several options, actually, but they can be complex and require the creativity, flexibility and willingness to take action we mentioned above.
The first option is to sublease. Most leases contain provisions for a tenant to sublease space subject to the landlord’s approval of the subtenant’s use and creditworthiness. Since Bob is paying a below-market rate of $.83 per square foot, he should be able to sublease the space at a higher rate to cover the cost of the process. He has 2+ years of remaining term. So he will have to find a tenant looking for short-term space, which in today’s environment is realistic, if not optimal. But, if he subleases, the remaining lease term will still be on his books as a liability, which is definitely not optimal.
A more advantageous outcome when taking the sublease route is the making of a new direct lease with the landlord that effectively terminates the original lease. In this case, Bob would find a suitable subtenant with good credit who is looking for a longer-term. The would-be subtenant then negotiates a new direct lease with the landlord. Bob pays a fee for unamortized landlord costs in return for the lease being terminated without further liability. This is a real win for all parties. Bob walks away, the prospective subtenant gets a new direct lease for a longer-term and the landlord resets the rent to reflect the current market. We have successfully completed this process many times. Complicated and challenging? Yes, but a good option for all concerned because it plays right into the current market dynamics of short supply and rising lease rates.
A third option is a lease termination agreement with the landlord. If the current rent is far enough below market, the landlord may be motivated to terminate the existing lease for Bob if he has another potential tenant in mind for the space. This is often the case with institutional owners who are managing large portfolios of tenants whose needs are changing over time. They may have an existing tenant in the same predicament who is looking for exactly what Bob no longer needs. The lease termination allows the landlord to keep his tenant within the portfolio, which minimizes future rental income loss.
No matter what option Bob chooses, he must secure a new space for himself to make the deal happen. That means he has to get out in front of the process by aggressively pursuing other options while his current space is being marketed for sublease or while the termination agreement is in negotiations. The timing can be tricky, but the results can be well worth the effort.
Our primary message to all tenants is: Always Be Looking. Waiting until the last minute will not end well. Get out there and find what you’re looking for as if you had no existing lease obligation. That may sound like a waste of time, but it isn’t. We are more than willing to help you find the right opportunity and we have gone through this process enough times to know it can work. The search for space is the least time-consuming component for you. If we can find what you’re looking for, we can use the supply shortage to your advantage and put you in the space that truly meets the needs of your business.
Give us a call to discuss your current situation and your options. We’re here to help.