By: Bill Boyd
Office tenants today are now, more than ever, looking for any means of identifying business cost reductions and savings. Some are finding it within their lease document.
As most of the major office buildings within this local office market are now owned by institutional ownerships (pension funds, insurance companies and related finance companies) the office leasing process has become less creative and far more rigid. However, there are a few methods tenants can employ to reduce their own cost of occupancy.
The concept of "free rent" first showed up in the Tri-City office market in the early 1980's and then later in 1987 when four new buildings were completed in Glendale alone and the office vacancy exceeded 20% of the total office space in the city. (One notable Glendale building was providing the first year of a lease free over a five year lease term.) Many would appreciate that, technically speaking, there is no such thing as "free rent" because either there's rent or there's not. The term rent abatement accurately describes the practice of providing occupancy without charging a tenant rent. However, there's a significant difference in the market today over years past. The institutional office buildings resist any abatement of rent primarily for the impact (reduction) it has on asset valuation. So, what's a tenant to do? Glad you asked.
Tenants are finding value, and, added dollars, in their lease by requesting, and, achieving, a "prior occupancy" provision in their lease that can avoid any rent abatement, and, therefore, allow the building ownership to maintain its rental rate assumptions.
The prior occupancy concept is a very simple process whereby a tenant is provided occupancy of the space (without paying rent)prior to the lease term commencement date. Typically, for a five year lease term, some tenant's are achieving from two to five months of occupancy in the space prior to the lease commencement date so that, therefore, the tenant is occupying the space for 62 to 65 months while only paying rent for the five year lease term. This allows the building to "book" a five year lease term, and, therefore come closer to its rental rate underwriting assumptions while the tenant can experience the cost savings provided by such prior occupancy. In one recent Glendale office lease, five months of prior occupancy were provided for a subsequent five year lease term at a rent of $2.50 per square foot per month, so that, the effective rent over the 65 months was $2.30 per square foot per month over the tenant's occupancy term. Some tenants do this math for the first year of occupancy. In this case, the tenant's effective rent will be $1.45 per square foot per month during the first year of its occupancy!
Tenants are achieving other cost savings in such other areas of the lease as the amount of the construction allowance being provided by most buildings. Some buildings are providing interior construction allowances in excess of what the actual cost of the construction (for the tenant's interior space) will be (as a means to justify, for the tenant, the higher rent being paid above the effective market rent). The remaining allowance left over (not utilized for the tenant's interior construction) is credited to tenant in just about any other area of the lease except the all important rental rate. Most tenants don't mind taking such "credit" in additional free parking (another concept that lowers the tenant's cost of occupancy but maintains the building's rental rate) or other reimbursements towards moving costs, data cabling or other tenant expenses.
Many tenants in this market have achieved a "cap" on controllable operating expenses within their building. Such "controllable" expenses are those typically the landlord contracts for such as janitorial service, security, parking and just about anything else except the building's taxes, utilities and insurance costs. This cap prevents excessive "pass through" to the tenant (charges to the tenant for the increased cost of such services over the prior year of the lease) as such expenses are subject to the landlord's control.
While the Tri-City office market has seen the type of leasing slowdown that is now being experienced before there are still several methods of achieving the expectations of both landlords and tenants alike. Providing tenants additional cost savings, that may not be initially apparent, is still achievable. Several of the experienced office brokers within this market will readily point out where those savings can be found.
"Bill Boyd has been active in the Tri-City office market since 1981 and has leased and sold over $1.8 billion in office space and office buildings in this market. He is currently a principal with Verdugo Consulting, LLC and can be reached at 213-595-0718."