How Early Should You Sign a Lease Renewal?
The Right Time to Start Discussions, and Other Advice for Tenants
Some commercial real estate brokers believe it's never too early to start negotiating a lease renewal. The earlier they get their foot in the door, the less likely it is that they will have to compete with other firms for the tenant's business. Unfortunately, there is such a thing as "too early."
While an early lease renewal can sometimes provide a win-win outcome for the landlord and tenant, the question every tenant must ask before committing to such a transaction is, "Is the renewal deal compelling enough to forgo market competition and the benefit of additional time for me to assess the future?"
When to Accelerate
Parties often start discussing a lease renewal 12 to 24 months prior to the expiration of the existing lease depending on the size of the requirement. However, if the tenant or landlord has pressing business needs, it may be appropriate to accelerate this process—for example, if the tenant has a need for more or less space, needs to address an immediate cash flow problem, or needs additional improvement dollars. Or, if the landlord is positioning its asset for sale or refinancing, or trying to manage its immediate lease rollover exposure.
For the purposes of this article, we will define an "early renewal" as any renewal that occurs before other landlords would be willing to compete for the tenancy. We will also assume that the tenant's primary objective in executing an early renewal is to generate real lease savings.
Unfortunately, the savings realized in the beginning of many early renewals is often more than offset by rent premiums in the latter part of the term and below-market tenant concession packages. Why? Because the landlord often has the upper hand in these types of negotiations.
Early renewals deny tenants the ability to shop their requirements with other landlords, which is the most certain way of securing the best pricing. If the tenant's lease expiration date is too far out to attract the interest of other landlords, the current landlord has no pressing fear of losing the tenant. Landlords rarely put their best deal on the table when they are not competing with anyone.
When to Wait on Renewal Discussions
If the tenant defers renewal discussions until other landlords are ready to aggressively compete for its deal, its current landlord will have no choice but to be aggressive. The other landlord proposals also provide the tenant with a benchmark against which to evaluate its renewal alternative. Thus, in the absence of a compelling business reason to renew early, tenants should only accept these deals if they are so compelling that competition is unlikely to improve them. The only way to assess this is to create comparative financial models and make reasonable assessments about what the market is likely to be when the lease is ripe.
Another problem with early renewals is that they deprive tenants of the benefit of time. Because lease terms are often five years or more, tenants need to project their staffing needs into the future so they don't take too much or too little space. The longer a tenant can defer its space decision, the more current information the tenant will have about its business and the economy to predict future needs. Thus, a tenant considering an early renewal should ask not only whether it is really saving money over the long term by doing the transaction now, but also whether these savings justify the risk of an accelerated decision with incomplete information.
While there are many reasons why a tenant may want to secure an early lease renewal, if the tenant is looking to minimize total occupancy costs over the lease term, they should carefully evaluate the proposal with its advisor by modeling against likely future market scenarios to see if waiting is better. Further, tenants must determine if the benefits of a new, accelerated lease deal justify forgoing the opportunity to assess their business prospects over the remaining lease term.
About the Author: Glenn Blumenfeld
Glenn Blumenfeld, CEO of Tactix Real Estate Advisors, has managed many large tenant transactions in Philadelphia and the surrounding regions, including representation for the two anchor tenants at Cira Centre and FMC Corporation as the anchor tenant in FMC Tower. He is a frequent lecturer, a frequent guest writer for the Philadelphia Business Journal and author of two volumes of The Tenant Survival Guide: Strategies, Perspectives and Insights Exclusively for Tenants.