Business, Profits and Strategy

Andrew B. Zezas, SIOR
Relationship Manager,
Strategist, President
(908) 245-5999 x11
andrew.zezas@realstrat.com

"Is Your Company Generating Too Much Profit for Your Landlord?!"

Part One of a three part series appearing in the March, April, and May issues of “Business, Profits and Strategy”

When renewing or renegotiating office space leases for your company, have you ever considered how construction allowances, free rent, operating expenses, real estate taxes, and other landlord-paid costs impact his or her profits? Well, given how those profits could affect your real estate costs, if you haven’t considered them, then perhaps you should. Some landlords will have you believe that due to the high cost of securing a tenant and completing a transaction, they don’t make much profit on individual leases. In some cases, that may be true. However, if landlords could not generate acceptable profits on most transactions, the real estate industry would likely collapse and thousands of landlords would quit the business.

I am certainly not suggesting that landlords are not entitled to profits. After all, profit and capitalism are what makes the world go around. And, neither do I intend to offer an opinion as to how much profit a landlord, or anyone else for that matter, is entitled to. But, your company may have a very different opinion. And, keep in mind that how a landlord does business, the returns he or she seeks, how their buildings are financed, how they negotiate, and the specific costs associated with particular transactions will vary.

Lease Renewals

In many cases, initial leases require substantial investments of capital on the part of landlords. Interior construction allowances (also known as tenant improvement allowances), building upgrades, free rent, advertising, professional fees, permits, operating expenses, repairs, property taxes, and more, very often serve to reduce landlords’ profits. The landlord will also bear the financial burden of heating, and maintaining vacant space, as well as, lost rent (downtime) while he or she seeks a new tenant and, in many markets, while it constructs the space for that tenant.

Compared to an initial lease transaction, renewals typically don't place the same financial burdens on landlords. Renewing tenants rarely require anything close to the same interior construction allowances as new tenants, and other transaction costs tend to be smaller, too. Seldom does downtime exist between the original lease rental payments and those associated with a renewal. Most often the landlord will only be responsible to make minor upgrades to a renewing tenant's premises, such as a coat of paint, the installation of new carpets, and some repairs or changes. Landlords count on tenants’ renewals and expansions to create lower cost transactions that will generate higher profit margins.

Here's the math:

New Tenant Transaction Costs (projected for 10 year lease*)	Renewal Transaction Costs
TI: $25.00	TI: $10.00
Marketing: $1.00	Marketing: $0.00
Free Rent: $10.00	Free Rent: $0.00
Downtime: $20.00	Downtime: $0.00
Commissions: $10.00	Commissions: $10.00
Misc.: $5.00	Misc.: $5.00
Total: $71.00	Total: $25.00
	Differential (Additional landlord profit margin): $46.00

* Actual costs will vary from market to market and from transaction to transaction.

Gone are the days, at least for now, when a tenant could move into one of many new buildings where, as a result of aggressive new construction financing, the rental costs in the new building would be substantially lower than those of in-place renewal alternatives. And, contrary to what often occurred years ago, seldom will competing landlords absorb a tenant's remaining lease obligation in its former location as an incentive for the tenant to relocate to the landlord's competing building.

Moving a company has become considerably more challenging, time consuming, disruptive, and costly for tenants over the years, especially given the complexities of technology and equipment. Companies not seriously considering relocation will typically wait too long to address real estate. Accordingly, landlords can be well positioned to take a hard line in renewal negotiations and as a result, can often win on some or many levels. And, because of the burdens placed on tenants when relocating, most of which do not exist when tenants renew leases in-place, most landlords seek to extract rental premiums from renewing tenants.

Missed Opportunities

Another source of landlord profit is how operating expenses, maintenance, and property taxes are treated under a renewal transaction. Escalations of these expenses can be carried forward into a lease renewal, thereby increasing a tenant’s actual occupancy costs, if they are not addressed as part of an overall financial negotiation. These landlord profit centers are often overlooked by renewing tenants who only take a "reduce our rental rate" approach, or when these items are negotiated away by landlords, thereby creating a windfall for landlords.

Read Part Two of this article in next month's issue of "Business, Profits and Strategy"

Andrew B. Zezas, SIOR, is Relationship Manager, Strategist, and President & CEO of Real Estate Strategies Corporation, Publisher of "Business, Profits and Strategy", a monthly online publication read by thousands of business, financial, and real estate executives nationally, and, is the author of two new real estate books, The CFO's Guide to Understanding Corporate Real Estate Transactions and The CFO's Guide to Hiring the "Right" Real Estate Service Provider, both of which will be available shortly at www.thecfosguide.com.

Mr. Zezas is well-known for his ease and informative style of public speaking, and has given talks, presentations, and has lead educational programs for business, professional, government, and trade associations, including the Building Owners and Managers Association, American Management Association, the U.S. Postal Service, RealComm, Society of Industrial and Office Realtors (SIOR), and others. Andrew is National Chairman of the SIOR Tenant Representation Specialty Practice Board, and is a licensed real estate instructor in Texas and Indiana. He can be reached at 908 245 5999 or via email.

Real Estate Strategies Corporation, located in Kenilworth, New Jersey, and serving clients throughout the country, helps companies create and execute Business DRIVEN Real Estate Solutions...and Opportunities, faster and with less risk. Visit www.realstrat.com.

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