Myth: Hiring a Broker Will Increase Leasing Costs
Filed under: Newsletters |
This article will once and for all dispel the myth hiring a real estate broker will increase your leasing costs. Landlords will take advantage of a defenseless tenant. Would you negotiate a $750,000 government contract without an attorney? Would you buy a $4.0 million company without your accountant or attorney? Then why wouldn’t you hire a commercial broker to negotiate a lease with total rent payments over the term of the lease totaling $750,000.
Let’s quantify the” increase” in leasing costs to the fictitious company Great Pacific Capital (“GPC”) if it does NOT hire a broker when it renews its lease for another five years. GPC leases 5,000 square feet in a typical class B office building in Northern Virginia. GPC is paying a $26.50/sf rental rate and the lease expires November 30, 2010. The market rental rate for renewing leases for this and competing buildings, assuming a “good” credit tenant, is approximately $23.00/sf based on a five year lease with 3.0% annual increases, a $20.00/sf tenant improvement allowance and two months free rent. Does GPC know what “market” terms and conditions are? Highly unlikely unless they have hired a broker!
GPC initiates contact with its landlord to renew their lease. The landlord and landlord’s broker are salivating because GPC has not hired a broker. The landlord’s broker will tell your company it will pay a lower rental rate, or pass the savings to your company, if you do not hire a broker. The landlord’s broker informs GPC they can renew their lease at the current rental rate of $26.50/sf and the space will be repainted and re-carpeted at a value of $7.50/sf. After two months of intense negotiations GPC and the landlord agree to a $25.00/sf rental rate with 3.0% annual increases over a five year term with a $10.00/sf tenant improvement allowance and one month free rent. GPC is now bragging about the great deal they negotiated with their landlord. Why not! GPC’s rental rate will be $1.50/sf lower ($26,500 in savings over 5 years) and will receive a concession package valued at approximately $60,400 which includes a tenant improvement allowance and free rent.
Landlords do not pass their savings to tenants. Over the five year term GPC is going to pay $53,000 (8.7%) more rent than “market” rent and receive $60,400 less in “market” concessions. GPC has been “taken” for almost $113,500 in lease value. How does GPC’s owner feel now? If GPC does not pay its lawyer or accountant a premium for their services then why should it pay its landlord a premium for leasing space? The author worked as an asset manager for building owners and was responsible for negotiating and approving leases as well as developing and executing property level budgets, among many other duties. Lease commissions were always budgeted to be paid on lease renewals and new leases to pay the brokers representing those tenants! What motivates each party and what are the benefits received? The landlord’s broker is motivated to lease the space quickly at the highest rental rate and without a tenant’s broker to maximize their lease commission.
The lease commission earned by the landlord’s broker doubles to about 4.0% from 2.0% if GPC does not hire a broker. The landlord is motivated to achieve the highest rental rates and minimize capital costs (lease commissions, tenant improvements and free rent) to maximize the property’s investment return. Landlords do not just lower the rental rate for a lease renewal. Some might. What are the benefits, if any, to GPC? None! Keep in mind these concepts also apply to tenants negotiating a lease when relocating to another building or expanding within their existing building.
Rent, the tenant improvement allowance and free rent are by far the largest and most important economic considerations in a lease negotiation. There are however numerous other monetary lease considerations that should be addressed in any lease negotiation. If not addressed, a company may end up paying higher operating expenses or incurring unnecessary, higher or landlord profit-driven fees. For example, GPC should negotiate to reset the base year upon its renewal and require the landlord to pay for all costs to move furniture so the space can be painted and re-carpeted.
Many tenants miss this costly requirement when reviewing language on their own. Other examples include landlords passing through capital improvement costs; administrative fees on services provided; above-market insurance coverage for a given use; landlords passing through costs for code issues existing prior to lease commencement; and landlord requiring expensive audited financial statements.
