Further Thoughts on Phantom Space

Recent media commentary has focused on the existence of “phantom” space in the New York City real estate market. One report found that over the last fifteen years, approximately one-third of a random sample of fifty properties in Midtown “grew” their rentable square footage ("rsf") on average greater than 5%.

 For every $40.00/rsf of base rent and compounded at 3% (as many office leases currently do), the cost of this space exceeds $2.28/rsf per year over a ten-year term. In weighing in on this discussion, I would like to highlight three important issues to bear in mind:

The commercial tenant has little control over the landlord’s measurement of space. (As the tenant’s aggregate annual rent is the product of the landlord’s measurement and the negotiated base rent, the tenant can really only negotiate the latter multiple). We advise our clients, as part of their due diligence in leasing, to measure each candidate space and make economic comparisons based on the actual, or “usable” square footages or "usf".

This way, each landlord is subject to the competitive pressures of the marketplace. In order to accomplish this comparison a tenant must do two things: 1) engage an architect or project manager to oversee the measurement process and 2) adjust the project planning timetable accordingly to allow time to prepare measurements. Both of these activities are key activities within the scheduling component of my firm’s project management portion of our integrated leasing services.

Base rent costs are only one of many ways in which landlords can improve a building’s profitability. In fact, base rental costs only account for approximately 55-70% of total occupancy costs over a ten-year lease term. Other landlord profit centers include: Operating Escalations, Real Estate Taxes, Utilities/Electricity, Construction Costs and Janitorial Services, to name a few. A typical landlord’s standard lease document represents an aggregate set of that landlord’s historical contingencies, particularly those that lost him (or her) money. It is critical for the commercial tenant to assemble its own team of experts (brokerage, legal, architectural, engineering, technology, etc.) to offset the landlord’s team of internal advisors. Personally, I try to offer my clients a pre-bundled integration of team members in support of my role as transaction manager and single point-of-contact.

One way to avoid the landlord’s ability to remeasure space is to work off of the original lease document and make modifications via amendment to that original document. This happens most often in the case of fixed option clauses in the original lease to either: a) expand or contract or b) to renew the lease for any number of subsequent lease terms. Again, negotiating such flexibility options will increase the time it takes to negotiate a lease, so a project schedule must be expanded accordingly.

However, it is well worth the additional time invested, as we know of a Fortune 500 tenant in NYC that recently let a renewal option lapse, only to have to release the option space at a remeasured number and at current market rents. This mistake increased their base rental costs by 37% per year. When amending an older lease document, however, it is critical to remember to update any base years for operating or tax escalations to a more current base year, otherwise the tenant will be paying escalations immediately and on an artificially low base year.