Commercial Real Estate Leasing – Common Sense And Shifting Paradigms

Aaron Weiner

By Aaron Weiner

Negotiating a lease with a building owner is something you only do once every five years or so. Yet, after your human resources, real estate expenses are your second greatest business expense. For the readers that lease office space – and for your clients that do – below is a primer on some of the fundamentals of effective negotiations and a look at some of the new trends that impact your mission critical real estate decisions.

CORPORATE IMAGE: INSIDE VS. OUTSIDE
Your corporate image and culture is projected in many ways, including your branding and marketing materials, but perhaps in no way more dramatically than in your place of business. Tenants, be they retail, office, or industrial in nature, often choose buildings based on their outside appearance or “curb appeal.” While there is no discounting the way a building looks from the street, experienced and knowledgeable real estate brokers know that what you see isn’t always what you get. Less experienced brokers and naïve tenants overlook the fact that there are two distinct audiences for corporate culture: the outside world (their clients and the public at large) and no less important, their employees.

On the outside is the architecture, the building skin of granite or glass, the expansive lobby and the corporate identity of a major tenant on the top of the building, but what is important to your valuable employees? Think ease of parking, the speed of the elevators, the smell of the bathrooms, the design of the suite and the amenities in the neighborhood. What do you think it does to productivity to have your employees chronically complaining that they are too hot or too cold in their work area, or worse, going home feeling sick because they are hypersensitive to these temperature extremes? Or when they take longer lunch breaks because the food amenities located in or nearby the building are scarce? Or when there are no places nearby to network and socialize after work?

How else does a building impact your business operations? Is that impressive grand lobby in your three-story suburban building inflating your rentable square footage and costing you more relative to other alternative buildings? Are you setting yourself up for surprise billings from the landlord because they are doing a poor job managing building operating expenses? It might surprise you to learn that these are all things a good real estate broker can identify before you sign your lease.

Think about it: those companies rated as “the best places to work” in your local business journal never cite the exterior appearance of the building. It’s all about happy employees and happy employees make for happy clients.

“CREATIVE OFFICE” MOVING FROM THE FRINGE TO THE MIDDLE
Once and for all, let’s put the worn out term “creative office” behind us. Used to describe the workplace of technology startups and flip-flop wearing millennials, the term was abused and perverted by the real estate profession, I’m sorry to say. First and worst of all, they tried to define creative office by a type of building (old, obsolete industrial buildings with bow truss ceilings) and where it was likely to be found. the archetypal locations in the Los Angeles region have been Santa Monica, Venice, El Segundo, Culver City, Hollywood and the Arts District in downtown L.A. However, the misguided definitions of building construction and zip code miss the point. the emerging new concepts about the communal office are about the people and the work – and it can take place anywhere that a community can thrive.

If the primary creative office precept is collaboration, then it can flourish in a dense, vertical downtown community brimming with cultural institutions and richly programmed public spaces. It is starting to happen in places like downtown Los Angeles and Westwood.

Another perception that is being trashed is that “creative office” is just for technology companies. I have law and accounting clients that are shifting to more open plan, team work layouts. No longer relegated to the “creative” pigeon hole, a new paradigm of productive office space is here.

OPERATING EXPENSES CAN BE A MINEFIELD
If you are a tenant at a property with a single building, your share of operating expenses and property taxes is an easy concept to understand. However, in most multitenant office buildings, leases are structured as “full service gross” where the rent includes the tenant’s share of operating expenses for the first year, or “base year” of the lease; in subsequent years, the tenant is charged only for increases over those base year expenses. Are you confused already? It’s not unusual and all the more reason to have a knowledgeable advocate in your corner.

The calculation of these increases is where tenants can be cheated. For example, let’s say you leased space in a building that was 50 percent occupied when you moved in. Would the building’s electricity expenses be lower that year than in a future year when the building is 85 percent occupied? Absolutely, yes. Let’s do a little quick math. If you occupied 5 percent of the building and the base year electricity cost was $25,000, 5 percent would be $1,250. In that future year with the occupancy up to 85 percent, the electricity cost is $42,500 and your share is $2,125. Therefore, your share of the increase over the base year is $875.

But wait. Look at a utility bill in each of the two years. The utility’s rate per kilowatt hour has not changed! If this doesn’t seem fair, you are right. A well-written lease should state that occupancy- sensitive operating expenses (like utilities and janitorial services) for the base year and all future years must be adjusted to reflect an occupancy constant like 95 percent or 100 percent. If that rule is in the lease and properly adhered to, the increase of electricity costs over the base year charged to you in the scenario above would be zero.

A good real estate broker with some property management experience will have your back. Be sure you have one looking over your shoulder. It could save you an arm and a leg!

PROPERTY MANAGEMENT IS AN 80/20 PROPOSITION
Most commercial tenants think of property management and say, “Thank goodness the landlord takes care of that!” That is largely true in multitenant buildings, but to think it is entirely so is to put your financial bottom line into the hands of the landlord or property manager – at best a well-intentioned stranger and at worst a totally indifferent one. While it is true that a tenant in a large Class A office tower does not have to perform janitorial services or maintain the building’s heating and air conditioning systems, they do assume significant repair responsibilities inside of their premises and have important administrative duties relating to property management.

Think about it — for every bill you receive, whose responsibility is it to review it for accuracy and actually cut the check? There is not a lot of review required when you receive a utility or cable TV bill at home, but what about that annual operating expense reconciliation letter you receive from the landlord? Does it accurately reflect the terms of your lease; in particular, the special operating expense lease provisions a seasoned real estate broker should have negotiated on your behalf?

Eighty percent of property management is shouldered by the landlord, but 20 percent is the tenant looking out for their own interests. Who is looking out for yours?