What to Consider When Negotiating Your Next Lease
A lessor is driven by the annual cash flow and term of the lease, the creditworthiness of the lessee and the sufficiency of related collateral pledges, deposits and guarantees. Longer-term leases with financially strong lessees provide stability to lessors and their lenders and can serve to minimize the costs of lessee turnover.
Re-leasing space involves significant costs, such as vacancy periods between tenancies and brokerage commissions, which are, in large part, borne by the lessor. Other costs of re-leasing, such as up-front incentives and new lessee improvements, typically end up being shared by lessor and lessee through the negotiation process. While free rent periods solely benefit the lessee, improvements to the space can often benefit both lessor and lessee by making the space more desirable and enhancing the lessor’s residual and re-lease value. Accordingly, most lessors prefer to contribute dollars in the form of higher tenant improvement allowances rather than additional free or discounted rent.
Lessees try to minimize their financial exposure and maximize their flexibility. Few lessees can predict their space needs over an extended time period. A lease signed today is almost certain to involve too much or too little space in several years. Termination or escape clauses and various expansion and renewal options are provisions lessees are strongly interested in when negotiating a lease. Because relocating is an expensive process (direct moving costs as well as significant losses in productivity due to down time), lessees often look for compensating up-front cash incentives and reduced or free rent during the early portion of the lease term. The up-front incentives may include reimbursement of moving costs and subsidies for the remaining life of the lessee’s “old” lease.
The economics of a particular lease situation should drive the negotiations. However, there is usually more than one way to reach a desired economic result, allowing the parties to conclude the negotiations in a manner that meets the economic and tax interests of both parties.
Ask Our Experts
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Rebecca Machinga, CPA, CGMA 609-520-1188 [email protected]
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To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
