Leverage Project Management Up Front to Construct the Ideal Lease

As a commercial tenant, how did you gauge the success of your last transaction? Chances are that you measured it by the difference between the current market rental rate and your negotiated lease rental rate. You certainly are not alone in using that assessment. Even a $2 per rentable square foot ("rsf") differential from the market rental rate can add up quickly. On a 50,000 rsf, ten-year lease term, for example, the savings would translate into a significant savings of $1,000,000.

 However, by focusing solely on the base rental rate, a corporate tenant could ultimately stand to lose multiples of these negotiated savings.

A standard New York City lease document consists of hundreds of pages and resembles a telephone directory - within these leases there are at least 100 negotiable items that can offer significant savings for tenants. These range from smaller items like monthly surcharges for overtime air conditioning, freight elevator usage and water charges to more substantial matters such as sublease, assignment rights and flexibility options.

To maximize savings potential, a tenant must negotiate all of the items relevant to their company’s specific circumstances. In order to negotiate effectively, one must ask the following questions which are crucial to the success of any transaction: Is the assessment of your space needs accurate? For instance, are you sure that you need 30,000 rsf over a ten-year term or could your space be programmed more efficiently to utilize only 28,000 or even 25,000 rsf? What about the potential for expansion or contraction during your lease term?

How consistent is the comparison of base building conditions from property to property? Have you identified all of the deficiencies of base building conditions when comparing each alternative? If the landlord is not held responsible, what is the tenant’s cost to upgrade mechanical, electrical or safety systems? A seemingly equal comparison of two properties with identical quoted base rents is not truly appropriate if one property requires additional expenses to upgrade and equalize the base building conditions.

Do you really know how much of a tenant improvement allowance you will need? Have you accounted for all construction and non-construction costs? The budgeting process is essential to negotiating an appropriate tenant improvement allowance. Additionally, if you are employing a project manager, landlord oversight fees become unnecessary.

When can you realistically take occupancy? This estimate must account for all factors, including scheduling and approval of design, permitting and expediting, all construction phases, furniture ordering, delivery and installation, technology installation, the physical move-in and any other miscellaneous work.

Typically, when a company conducts a real estate transaction, project management is not considered until the ink is dry on the lease document. However, by then it is too late since any negotiating leverage has disappeared. However, to accurately address the considerations above, you need to enlist the appropriate expertise up front. Increasingly, corporate tenants are realizing the value of bringing project managers into the initial phase of the process – the strategic phase – to assist in creating a stable foundation for cost savings throughout the transaction and the project.

An integrated team that includes a project manager and a real estate adviser facilitates more aggressive negotiation and avoidance of costly mistakes by helping to accurately identify both short- and long-term space and infrastructure needs; assess building deficiencies; establish a project budget inclusive of technology, furniture and relocation costs; and determine a realistic occupancy date.

Consider this scenario: A company has signed the “perfect” lease in Midtown Manhattan. The space is in an ideal location for the combination of client visibility, work force recruitment/retention and employee commutation. The 50,000 rsf lease consists of a competitive rental rate that is $3 per rsf below quoted market rental rates over a ten-year term, plus six months of free rent. At first glance, this equates to approximately $2.5 million savings.

However, problems arise when the company is unable to meet the scheduled occupancy date. In fact, scheduling delays due to unanticipated permitting back-ups and furniture lead times have pushed occupancy out by at least three months, resulting in the loss of free rent and a costly holdover penalty (200% of existing rent) on the current lease.

The company’s situation only gets worse when it comes to light that it actually needed only 42,000 rsf, not the 50,000 rsf committed to in the new lease. And, upon closer review, the tenant improvement allowance negotiated at $40 per rsf really needed to be closer to $55/rsf. Taken as a whole, the “perfect” lease is not so perfect anymore.

In this example, the inaccuracies and improper planning tally up to major expenses. The 8,000 rsf of surplus space at $40 per square foot over a ten-year lease equals $3,200,000. At $15 per rsf, the tenant improvement allowance shortfall comes to $750,000. Additionally, the lost three months of free rent is another $500,000, not to mention the holdover penalty of $1,000.000. That’s a total loss of over $5.45 million – more than doubly offsetting the originally projected savings.

Bringing project management into the fold before negotiating the lease could have avoided much of this expense as well as the surprise and accountability issues associated with the unraveling of the “perfect” lease. Clearly, this hypothetical case study illustrates how project management’s upfront involvement can not only increase cost-savings opportunities but also help avoid unnecessary expenditures and schedule delays.

Having an experienced corporate real estate adviser representing the tenant’s interests, in conjunction with bringing project management into the due diligence and negotiating phases of the project, not only assists the tenant in all of the decision-making stages, but also ensures that previously unforeseen costs will be minimized. It is the early integration of project management and transaction services that generates maximum benefits. Combining the preplanning expertise and management skills of project managers with the market knowledge and negotiating savvy of corporate real estate advisers generates efficiency, continuity and accountability.