What isn’t on the MLS?

Since New York City commercial real estate inventory can almost all be found in a multiple listing service it’s relatively easy to navigate availabilities.

At the same time, there is very useful information that isn’t readily available about each landlord and building that can be that can become relevant to tenants looking for a new office. If you have a specific need, your broker will likely have a few “go-t0″ buildings for each situation.

For example, I had a tenant that wanted an loft-style office in the flatiron district and we had identified an appropriate space on 20th street that was close enough to the budget and had begun negotiating. Negotiations were moving slowly and we were left with only about two weeks until their target move-in date.

I knew that this relatively large landlord moves at a normal pace and wouldn’t necessarily make sending the lease out for this small tenant a huge priority. The landlord had concerns about the tenant’s financial situation as the company was just bought out and the financial situation wasn’t crystal clear.  I had rented a few spaces in the building over the years and knew the lease rider was about 35 pages.

Basically, whether the tenant knew it or not, we had already run out of time if they wanted to be in by the first of the month.

One morning as I was reviewing the new daily availabilities, a similar sized and price space came available a few blocks away. I had done business with this landlord before as well and know he is very hands-on, has few availabilities, and therefore is easily able to focus on the spaces he has for rent and make a very quick deal. We could negotiate the deal in the matter of two days (as opposed to two weeks), and review the lease in a day (rather than another two weeks). This landlord’s rider is only (a ridiculously short) 2 pages as opposed to 35. The landlord would also be more flexible with reviewing the financials and place some value on speaking to the tenant in place of reviewing their paperwork with skepticism.

Had I not known this about the new landlord, I would have been worried about distracting the tenant from a deal we were already working on and wasting more time. Fortunately, I showed them the new space that day and we were able to work everything out quickly and smoothly (and saving a few thousand dollars on lawyer fees).

Another example I have from a few years ago was a fashion showroom that was negotiating a space on 5th avenue and had a pretty good, but not stellar, track record. The sticking point was the landlord insisted on a 6 month security deposit to compensate for the average financials.

There was another landlord further downtown who I have experienced as being more accommodating so we signed a lease in flatiron with a 2 month deposit.

Other useful information that real estate agents typically make a note of is:

• Landlords that are accustomed to working with startup business and more accommodating
• Landlords that are more open to considering short term leases
• Landlords that typically require lower or higher security deposits
• Landlords that have ridiculously unfavorable clauses in their lease
• Landlords that are more responsible managing their buildings
• Landlords that are more accommodating and flexible moving around their tenants over the course of their lease
• Landlords that take a long time to negotiate terms and a lease (useful for tenants with a relatively distant move-in date and good to avoid if you’re in a rush)
• Buildings that have restrictive or expensive move-in policies
• Landlords that don’t pay appropriate commissions or are hard to collect from (not that the tenant will always care about this, but it certainly matter to the broker)

What should I look for when reviewing my lease?

Just like with anything else, it’s important to strike a balance between being too careful and being negligent.  Not reviewing a lease carefully or not using the right attorney can leave you vulnerable over the course of your lease. Proposing too many changes to a lease can cause the lease process to drag out, run up your legal fees, and possibly jeopardize the landlord renting you the space.

Especially on shorter term leases, remember, if you are paying your rent and don’t have any intention to sublease, it’s unlikely any of the finer points of the lease will be revisited. Of course, it does make it easier when you have a short, simple lease as opposed to a long, detailed lease, but most NYC leases are of the longer variety.

Here are a few things you should pay attention to:

• Base tax year: This is usually (but not always) addressed prior to drafting a lease, but it doesn’t hurt to double check that this is set to the appropriate year or you will be paying for it every year when real estate tax increases are assessed.
• Landlord Work: If you are the tenant, you want this to be as specific as possible. If the landlord has not committed in writing to do certain things, he is not obligated to. For example, things like types of finishes (marble, granite, stainless steel), dimensions of glass openings in offices, types of lights being used, hot water for your sink, a certain type of radiator, type of ductwork, and walls with specific insulation. If you don’t have it outlined in the lease and you sign it, you don’t have any recourse. Don’t go too crazy with it on insignificant things, but if something is important to you, I would make sure it’s explicit.
• Extra monthly charges: This will usually be spelled out before a lease is drawn, but some landlords will try to sneak a few in. Look out for things like water, sprinkler, carting, guard charge etc. Again, these will usually be presented beforehand, in which case you have already agreed on. But if they haven’t been, there’s no reason you should pay for them. I’ve even seen leases where they hold the tenant responsible for their proportionate share of toilet paper, paper towels, and cleaning supplies in the bathrooms!
• Insurance Requirements: Make sure they are appropriate to the size of your space and quality of the building. Remember, insurance is not that expensive and does benefit you so I wouldn’t make a huge issue out of this.
• Notice Period on Good Guy Guarantee: This will have the most impact on you personally if your company goes under so I would try to reduce this as much as possible. Keep in mind that the higher the security deposit is, the more leverage you should have on the notice period. For example, if you have a 9 month deposit, they might let you off the hook with 45 days notice. If you have a 2 month deposit, it might be 150 days. Typically, 90 days or less is pretty reasonable to have.
• Air Conditioning: If it’s a class A building, you are usually not going to be responsible, but if it’s a “B” or  ”C” building, you usually have your own air conditioning unit(s). If it’s a central a/c unit or window unit, you want to make sure it’s delivered in good working order and try to get a grace period on the replacement if it fails. For example, on a 10 year lease, try to make the landlord responsible for replacing the unit if it breaks down within the first 2 years. Or if you have 3 window units, have the landlord be responsible for replacing the first one (and you’re responsible for the rest). You’re also going to want the landlord to be responsible for the first servicing of the ac unit. Keep in mind that it’s almost always the tenant’s responsibility (and in their best interest) to keep a maintenance contract for central air if it’s in the space.
• Overtime HVAC: Especially in Class A Buildings, your hvac hours are probably going to be limited to a variation of normal business hours. Anything outside of that will be considered overtime and billed at a very high hourly rate (usually about $100-$200 per hour). Most people don’t ever use the overtime hvac, but make sure it’s not insanely high (I’ve seen $300+ per hour for about 2500 sf), and if it is, try to change it.
• Window Cleaning: It’s usually the landlord’s responsibility to clean the exterior of the windows in a Class A Building. In a “B” and especially a “C” building, it’s often the tenant’s responsibility to clean the exterior of the windows. It’s actually not as expensive as you think it would be (probably about $20-$50 a window), but I would try to get the landlord to clean them once for you at the beginning of the term and they usually stay pretty clean for a few years.
• Right to Expand Within The Building: Try to get ownership to agree in writing that you can expand into a larger space provided it is at least X% larger than your existing space. Obviously, the lower the percentage, the better, but I wouldn’t expect to get anything lower than 40% (at the lowest). It’s typically in the landlord’s best interest to accommodate a growing tenant as well so I wouldn’t assume the landlord has an issue with this if they don’t concede. Usually it’s to limit their liability (like most things in a lease).
• Late Fees: Make sure you have a reasonable grace period on rent payments and try to get the first late penalty waived, or even be permitted one late payment every few years if possible. Sometimes there are clauses stating if there are, for example, 3 late payments in a year, the landlord has the option to terminate your lease. Make sure the landlord can’t kick you out if you are two days late on your rent one time!
• Mandated Improvements: This means if the owner needs to upgrade anything required by the government, you have to pay your proportionate share. If at all possible, try to get this eliminated or restricted to a certain cap. This often won’t be in the lease to begin with.
• Use of Premises: Try to get this as vague as possible in case the nature of your business changes or you want to sublet. For example, you’re better off having “Office Use” than “Marketing Company” or “Travel Agency”.
• Holdover Clause: This can typically range from 1.5X the escalated rent to 3X the escalated rent. It is in your best interest to get this as low as possible (but don’t expect to get it lower than 1.5x in the best case scenario). This is particularly important if you end up subleasing the space for less than you are paying.
• Sublease Notice Period: Most landlords will expedite the approval process for subleases, but it will help to shorten the notice period so you can “promise” a sooner occupancy date for a subtenant that needs the space urgently (and get yourself an extra month of rent).
• Sublease Profit-Sharing and Right to Recapture: Landlords usually share about 50% of the profits from any subleasing, but make sure that it’s not anything more and keep in mind that they have the right to recapture, you may not ever get to profit. Also, make sure that the landlord gets 50% of the profits after all the expenses like brokerage commissions, legal fees, reimbursing the landlord’s legal fees, etc. They will also expect a percentage of any profits from furniture and fixtures sold (even though you bought them), but again, at least worth a shot to eliminate that.
• Sublease Approval %: Try to avoid requiring approval for subleasing less than 30% of your space (for example renting out an office within a law firm). Landlords usually won’t care anyway when it comes down to it, but better off not even having to notify them.
• Sublease Broker: Some leases may have clause requiring you to use them as the broker if you sublet. It definitely wouldn’t hurt you to have the choice of what broker to use. Sometimes you won’t get the choice, but it doesn’t hurt to attempt.

Make sure your lawyer is familiar, and preferably specializes in New York City real estate. It’s a relatively unique leasing process and often times attorneys that are not familiar with Manhattan office leasing will try to change things that are standard, which could result in giving you bad advice and causing you to walk away from a completely typical lease. They can also propose too many changes to compensate and turn off the landlord or unnecessarily lengthen the process.

The point of having a lawyer look over the lease is to make sure you are protected. If you have a friend that’s a lawyer and not a new york real estate attorney (and review the lease cheap or on the house), and they don’t know what they’re doing, it defeats the purpose. If I have a friend that’s a mechanic that works on motorcycles at a Honda dealership, I’m not going to ask him to replace the engine on my (hypothetical) BMW 5- Series and vice versa.

Most leases don’t have anything egregious in there, but every once in a while you find something preposterous. For example, I have seen a lease that gives the landlord the right to terminate the lease at any time for any reason with 30 days notice! Not only that, but they wouldn’t remove the clause, only change it to 60 days.

Needless to say, an experienced broker will let you know about something like this before showing (or more likely, not showing you) space in a building.

Eli

What if I’m too busy to look at spaces?

Sometimes I get a call from someone’s assistant or intern (or employee that just started a month ago) looking for space. The owner of the company is too busy to look for the new office. I don’t think it’s a bad idea to have an assistant weed through, meet, and basically interview potential brokers to prevent the owner from wasting time seeing the wrong spaces and talking to people that have no idea what they’re doing.

If and once a tenant finds a competent broker, it’s usually more efficient to communicate with them directly.  Sometimes it’s a matter of trust and people feel more comfortable putting their confidence in someone who knows them better (and they pay), and has a clear incentive to recommend the right places.

After all, if you could have your assistant just deal with a few brokers, why would you waste your own time dealing with them? The assistant could visit all the properties, take notes, take pictures of all of them and report back.

Or you could have an expert do all of this for free and have your assistant do the job you are paying him or her to do.  The advantages of dealing directly with one broker are easy to understand.

Your broker looks at offices all day every day for years. Your assistant has another important job to do and typically doesn’t have years of experience in commercial leasing. As stated already, you save money and increase productivity by keeping your paid employees or interns doing other work for your company

You can communicate your needs to your assistant, have your assistant relay them to your brokers, and then have brokers show your assistant the space. This is thorough, but here are few reasons this is less than ideal:

• The “telephone” effect. Since the message is being delivered through an intermediary, certain things may not be as clear and the reasons behind certain criteria might not be able to be explained.
• Efficiency. You still need to pay your assistant for the time he or she is out looking at properties and making calls. If you have a broker that understands your needs, the broker can visit the properties, make recommendations, and even take pictures to send you.
• Organization. If you have your assistant corresponding with three different brokers, each of which does not know which properties your assistant has already discussed or seen, it makes it difficult for the assistant and the brokers. The assistant needs to keep three different lists and the brokers need to guess about what properties your assistant has seen (or more likely just lose track of who showed what), not to mention you have three brokers calling the same landlord when a new space comes available all claiming to represent you. Eventually, the busier brokers will get frustrated and move on. If you have one broker organizing, keeping track of  everything, and getting all your feedback on the spaces you’ve seen, they will be in a much better position to make suggestions and evaluate properties on your behalf.
• It’s important to realize that new york commercial leasing is done primarily using a multiple listing service that contains almost every listing in Manhattan. Any broker with a subscription has access to the same database of listings which contains nearly everything. Most landlords hire brokers to promote their properties, but that does not mean you can only rent space in that building by calling that broker. The brokers are hired to maximize the exposure and the first step is usually making sure the spaces are on the MLS as soon as possible so all other brokers are aware of them. If you call ten brokers, they will all be searching the same database looking for space- it is rare that one will be able to show you something that the other one wont.
• Some brokers (likely the less desperate and probably more effective ones) will decide it’s not worth spending valuable time dealing with someone’s assistant since it can be less likely to be successful
• Some brokers (including myself) consider it a red flag when an assistant is being delegated to handle the responsibility because it could mean that the boss is “too busy” with other things. I usually interpret this as the search for the office not being as serious or urgent and the assistant is (knowingly or unknowlingly) just doing some research without the principal having the intention of actually renting a space (or renting a space any time in the near future). This would make some brokers, especially more experienced brokers uninterested in helping you.

Here’s an example of conversations I’ve had:

Assistant: We’re looking for an office in Manhattan between 14th & 59th Street for our marketing business.

Broker: Any preference within that location? Is there somewhere you’d really like to be? What’s your budget?

Assistant: It can be anywhere between 59th & 14th and we want to spend as little as possible.

Broker: Ok, well if I was going to send you options, what’s the most expensive you would consider? Also, when do you need to move and how long of a lease do you want?

Assistant: Would you be able to send the cheapest ones? We are flexible on moving and I’m not sure about how long of a lease.

From a broker’s perspective, you don’t even know how to begin to start looking and you’re also suspicious about how serious the company is about moving. You also suspect this person has already called a few brokers and will call a few more after you. You also don’t even know if the company’s expectations are realistic. You also recognize that you will need to show any spaces that the assistant likes at least twice since the decision maker won’t be seeing them unless the assistant approves.

If you have an agent that you trust, understands your needs, is keeping track of what you have seen, and is willing to preview spaces for you, you will save more time than having your assistant trying to act as your broker and run around the city with a bunch of different agents.

Eli

Should I have an issue giving a landlord a lease deposit?

During my first few months as a broker, I remember negotiating on a space in Midtown West and discovered the landlord’s broker required a deposit (of about $2000) from the prospective tenant in order to draft a lease.

I was disappointed and immediately asked if we could waive or at least lower the deposit amount. We ended up not seeing eye to eye on all the terms of the deal and never getting to the point of requesting a lease, but I walked away cautioning myself to be careful of bringing other tenants to the building because of the lease deposit.

A few years later I have instituted a lease deposit policy on some of my own listings. The vast majority of commercial landlords do not require any kind of deposit in order to send a prospective tenant a lease.  So wouldn’t I have a problem getting deposits from people?

Yes. Especially if they’re not committed to taking the space.

The reasons for the lease deposit are easy to understand:

• An attorney will charge an owner to draft a lease (and for any subsequent comments/changes)
• Owners typically put any other offers they receive on the back-burner once they have agreed to terms with a tenant.
• Often they will even discourage others from looking at the space

So the owner is making some commitment to the tenant (and spending a little money) and without a lease deposit, the tenant is free to back out of the deal at any time for any reason. This would cost the owner legal fees and cause him to potentially miss out on other interested tenants.

By asking for a deposit that is refundable in the event the tenant finds the legal terms of the lease unacceptable, but not refundable in the event the tenant reconsiders, the landlord knows the tenant is serious before spending money on the attorney and turning away other prospective tenants. They also receive compensation in the event the tenant backs out.

There are a few reasons a tenant would be reluctant to provide a deposit:

• They’re not sure they want the space
• They are deciding between more than one space and want to keep both in play
• They plan on negotiating further after they receive the lease (this is not considered an ethical practice and usually not tolerated regardless)
• Out of principle (since no one else is asking them for one)

The first three would all be good examples of how a landlord can use the deposit as a screening process. As far as the “Why should I have to give a deposit?” argument, a prospective tenant can usually appreciate the logic of why a landlord wants one.

They also gain some benefits. If a landlord has a deposit, the landlord is more confident about the deal, meaning they are less likely to show the space to others and are likely going to be more patient with the tenant. For example, if I didn’t hear from a tenant for 4 days after sending them a lease, I’d assume there was something up with the tenant and encourage a landlord to pursue other offers. However, if there was a deposit, I’d likely feel okay about it and let the tenant take their time since they’ve already committed.

They key is that a tenant should decide they want the space before they get a lease, not wait to decide until after they get the lease.

Here’s an example of a situation where I waived a deposit and lost a deal because of it. I had a small space at 36 West 44th street and two brokers submitted offers on the space with a couple days of each other.

Both tenants were willing to go very close to the asking price and in the range where the owner wanted to make a deal. The determining factor (as it usually is) was the track record of the companies and the amount of work each tenant was requesting.

We decided to go with the more established tenant that needed less work. We made the urgency of the situation clear to the broker and his tenant quickly signed the term sheet, but said he didn’t want to comply with the deposit because no one else needed him to.

We didn’t want it to be a dealbreaker so we moved on and I rushed our attorney to issue him a lease asap. After about a week of calling his broker and being told that the tenant will get back to us soon or that the broker is waiting to hear from him, the tenant finally admitted that was going to pass on the space and renew on his existing space unless we could drop the price from $40 psf to $25 psf.

Obviously, this was a ridiculous request and possibly an example if him planning to negotiate after he got the lease, rather than the surprise, last second development he made it out to be.

Obviously, my next call was to the other broker, but at that point, her (very serious) tenant had already locked up another space.

Had we stuck to our guns about the deposit, not sent the lease to the other tenant, and sent it to her (assuming her tenant would have complied with the deposit), we would have had the space rented (or at least had the first tenant’s deposit as a consolation).

I finished another deal in the same building last week. It was for a small space and with an international company so the lease negotiations took much longer than usual. I did receive a bunch of calls from other tenants that seemed like potentially great fits in the meantime. Had there been no deposit, I probably would have shown the space and presented any good offers to the ownership, tempting them to go with someone else or at least put more pressure on the other tenant to sign faster. Since we had their deposit, I just put them on a callback list and we ended up completing the deal without any unnecessary complications or added stress.

It’s important to understand that even though there may not be another interested party at the time you request the lease, there could easily be one the following day pressuring the owner for the space. The more certainty you give an owner, the less likely they are to show the space to other tenants and consider other offers.

To give another example of how a lease deposit simplifies the process of renting a space, a few years ago I was representing a landlord and we had three good offers on the same unit. The market was beginning to spiral downwards and we were worried about making sure we got the space rented asap.

The owner decided to send a lease to all three tenants and see who followed through (or who followed through first). In this instance, the strategy actually worked as two tenants were unresponsive and one signed the leases immediately.

However, I was put in a very stressful position and the other brokers and tenants certainly did not appreciate the approach (understandably). We also ran the risk of one of the less desirable tenants signing the lease before our top choice.

If we had prioritized which tenants we wanted most and offered them the lease exclusively provided they gave us a deposit, it would have gone smoother, we would have gotten our first choice and we would have avoided pissing off three brokers and tenants while accomplishing the same goal.

As a broker, now I am happy when I see that a landlord requires a deposit on a space my tenant wants. This way I know they are renting the space as soon as they get the lease, rather than worrying if they are just jerking me around for a few weeks and I can avoid the potential embarrassment of telling a landlord my tenant has backed out of the deal after we’ve already had the lease for a week. Or the irate phone calls from the landlord’s broker demanding that the tenant compensate them for their attorney’s fees or face a lawsuit.

Eli

How do I get approved as a start-up business?

The most important part of any offer is the prospective tenant’s financials. If you are a new business and don’t have anything to show, the owner may reject you outright or require a higher security deposit (6-12 months).

Everyone needs to start somewhere. You can establish a financial history while in a business center that barely has any financial requirements. Or you can approach a standard office lease with a couple solutions:

1) Personally guarantee the beginning of the  lease. It would be foolish for anyone that wasn’t unnecessarily wealthy to personally guarantee a 10 year lease, but it’s not unreasonable for someone to put their money where their mouth is for just the first year or two.

The term “personal guarantee” can give some tenants an allergic reaction, but as one landlord I know put it, “If you don’t even have confidence in your business, how can you expect me to?”.

After all they are signing the agreement and putting up the up-front costs with the assumption you will last the entire lease term. It would be a lot more justifiable for them if they knew they were at least getting the first year of rent (especially since the landlord’s upfront costs can often be equivalent to a year of rent if there is a build-out). Once you have paid rent timely for a year or two, the personal guarantee can revert to a good guy guarantee.

2) If your company is funded by, or is an offshoot of a larger company, you can have that company sign a corporate guarantee. This is the same concept as a personal guarantee and can also be dissolved or turned into a corporate good guy guarantee after a certain period of time.

3) Offer a higher security deposit that burns down as the lease wears on. Start with 6 months, after a year of paying rent, bring it down to 5 months, after another year bring it down to 4 months. This way if you go out business after two months, the landlord is well protected, but if you go out of business 3 years from now, you’re not getting killed on the deposit on top of it.

Keep in mind that things like having an impressive website can also help make the landlord feel more comfortable. Also realize that every landlord is different. I’ve had the same tenant approach two different landlords with the same financials and have one landlord offer her a 7 month deposit and another landlord offer her a 3 month deposit (guess which space she rented).  I recently even had one very responsible and knowledgeable landlord rent my tenant a space without even asking for financials since the tenant gave her a 3 month deposit (which is minimal) and signed a standard good guy guarantee. Granted, that was the first time in 5 years, but again, every landlord is different.

If you have the luxury of a few good options for space, it can be a good idea to submit your financials to all of them and see who is willing to be the most flexible on deposits and guarantees before you make your decision.

Eli

What if I don’t know how much my company will grow?

First of all, does anyone really know how much space their company will need in a few years? This is normal.

If you’re a startup or rapidly expanding business, the most logical fit is a short term lease, but since they are few and far between, what alternatives do you have?

1. If you’re doubling or tripling every few months, or are just starting with one or two people without an existing track record, a business center or executive suite might be the right temporary fit. You pay a much higher rate per square foot, but you have the flexibility of signing for often as little as 3 or 6 months and can quickly and easily expand with the center which can serve as an incubator for your business. All furniture and phones are usually provided and set up can be relatively seamless. It might be worth paying a few extra bucks to get you through a short uncertainty period and save you a lot of trouble and commitment.

Business centers typically don’t look into your financial background at all and require low deposits (since you are signing a “service agreement” and not a lease, they don’t need to spend up to 6 months evicting you.  If you default, they can just kick you out like someone that’s had too many drinks at the bar).

2. Sign a standard lease. This can often be as short as 3 years.  There are three common exit strategies for this

A) Growing within the building/portfolio. If you are bursting at the seams after a year and the landlord has a larger space for you (in the building or in another one of his buildings), the landlord will usually extend the first opportunity for his existing tenants to rent the space before it’s on the market.

This makes sense for the landlord since you are already prequalified (you already were checked out thoroughly when you signed the lease and have been paying rent since), he saves on legal fees since you have already reviewed and negotiated his lease, he won’t lose any rent on the upcoming space, and he can show your smaller and usually more in-demand space before you move. Obviously, he’ll also have less space available.

It’s not unusual for tenants to start in a small space and move five or six times over a few years into a very large space in the same building.

The advantages for the tenant are they can exit their current lease, they don’t have to go through a qualification process, don’t have to endure a lease negotiation (they can keep or adjust the already agreed points), and the move will be much easier.

In order for this process to work the most smoothly, there are a few key things to pay attention to:

• Although you will usually be accommodated regardless since it makes sense for the landlord too, it’s a good idea to insist there is a clause in your original lease stating you will be able to relocate to larger space as it comes available. There will be a percentage attached to this (usually at least 30-50% larger) since a landlord is not going to want to move you from 2000 sf to 2200 sf, it’s just not worth the trouble. There’s no reason a landlord should have an issue with this.  Don’t confuse this with “a first right of refusal”.  This is problematic for landlords because they may rent a space they did not think a tenant was interested in and then get sued by the tenant because he didn’t offer it to them first or because they didn’t decline it in writing (the landlord could get sued even if the tenant didn’t actually want the space). Also, they can’t give more than one tenant “first right”  so someone else may already have it.
• Make sure you are in a large enough building. Being able to move around is great if you are in a 40- story building with space coming available frequently, but it’s fairly useless if you have a full floor in an 8 story building.
• If you have a small space, going with a huge landlord might also be a bad idea. If you have 1000 sf and your landlord owns 10 skyscrapers, relocating you is not going to be their first priority.

B) Sublet or assign your lease. Finding a subtenant is not always a piece of cake, but if you are realistic with your expectations and have a nice space, and use a good broker, you will find someone.  If the market has sunk since you have rented the space, you should realize that you will probably still be taking a monthly loss on the rent even when you find a subtenant. However, if the reason you are moving is because of growth, your business is doing well and this is a legitimate expense that is aiding growth (and you are probably making more money).

If the market shoots up, you should be able to turn a profit on your space and/or rent it very quickly. For example, if you rent your space for $40 psf and two years later rents have increased 50%, you are paying about $43 psf (after 3% escalations) and the building direct leases are going for $60 psf. It would be easy for you to rent your space for $47 or $50 psf.

Keep in mind that there are usually clauses in leases that ownership will share your profits from subletting (after taking into account expenses like commissions, repainting etc). The percentage will be spelled out in your lease and can be negotiated. Sometimes the lease will even read that ownership will get 100% of the profits, which you should obviously try to bring down. Predictably, landlords will not share the sunken costs if you find someone to pay less rent than you are paying.

Since they are in smaller supply, sublets can be desirable for other tenants seeking short-term or even furnished space (if you don’t need your furniture anymore). Both can be huge selling points.

C) Go out of business. If the reason you don’t need the space is because your business has failed, you can dissolve the entity on the lease, adhere to the stipulations of your good guy clause (usually giving enough notice, leaving the space in good condition, and leaving on time), and can walk away smoothly.

3.  Negotiate a buy-out or cancellation clause in your initial lease. Not all landlords will be open to this, but some will if it is fair. A typically buyout amount is determined by holding the tenant responsible for the balance of the landlord’s unamortized costs, cannot be used until a certain point in the lease (or sometimes only at one point), and will require a notice period. Unamortized costs primarily consist of brokerage commissions and cost to build the space. If you’re anticipating growth, it can be a good idea to attempt to insert a buyout since you will still have the option of subletting or growing within the building, but having a more clearly defined exit strategy can be advantageous.

To summarize:

• If you’re growing extremely fast or starting really small, spend a few months in a business center.
• If you’re expanding and your landlord can accommodate you in a larger space, great!
• If you’re expanding and your landlord has no space, you can sublet or assign. You might lose a couple months of rent or eat a monthly cost, but remember your business is expanding (good problem to have) and you are probably significantly more profitable and can afford this cost associated with growing your business.
• If you have a buyout clause and decide to exercise it, again, it’s the cost of doing business and the reason you are exercising it is that you are making more money.
• If your business has failed, you can disband the company and walk away from the lease.

Besides, wouldn’t it be more disruptive and costly for your company to sign a series of one-year leases, spend the last few months of each year frantically looking for space (since you are on a deadline), spend money and time moving, and lose time with rent overlapping? Why not pick out a building, location, and landlord that’s a good match for you and move around within their building without losing any rent overlaps, negotiating any new leases, and without having to even walk out of your lobby to look at new space.

It might make more sense to do the work once every 5 years and then focus on your actual job rather than trying to look for space every year. If your company is growing, you are probably very busy doing other things!

Eli

Why can’t I find a one-year lease?

One of my most common challenges with first time nyc office tenants is conveying how rare it is to find a one year lease.  Companies looking to rent their first office in Manhattan will often assume that a one-year term is easy to get or even standard.

While there are a couple landlords that specialize in renting small, cheap spaces routinely for one year. Most landlords, especially in quality buildings require 3 or 5 year minimums.

You can stumble onto a sublet with approximately one year left, but I wouldn’t hold my breath waiting for one if it doesn’t pop up on your broker’s first run through CoStar. Trying to rent for a one year is like trying to lease a car for 9 months or renting an apartment for 4 months. It’s not impossible, but it is extremely difficult and your options are going to be severely restricted.

Why wouldn’t any landlord take a 1 year lease?

• Usually spaces need some work to get them into move-in condition. At minimum, it’s usually new paint and new carpet (or refinishing hardwood floors). Sometimes it can be demolishing or adding an office. This is not a major cost when amortized over 5 years, but for 1 year, it doesn’t make as much sense.
• Very aggressive landlords will prebuild space, spending a lot of money to display a beautiful, finished product. Often the cost of gutting a space is equivalent to about a years worth of rent. Clearly it doesn’t make sense to do this once a year (and leave vacancy time to rebuild and rent the space)
• Renting a space takes work. A landlord needs to approve the tenant, sometimes meet them personally, introduce them to the building, get them moved in etc. A landlord doesn’t want to have to spend his time doing this for someone that doesn’t want to commit to a long term tenancy in their building
• Legal costs: the landlord’s attorney still charges the same amount to negotiate a 1 year lease as a 10 year lease
• Brokerage commissions. A landlord pays less of a broker fee on a short lease, but since a standard commission schedule is lighter in the later years and also does not account for escalations, it’s less commission on average per year for longer leases. For example, a landlord will typically pay 5% of the first year’s rent for commission and 2.5% of the 6th year and he will be receiving over 15% extra rent in year 6 on escalations that he is not paying commissions on. This makes the commission for year 6 less than half of that for year 1.
• Renting a space takes time. Each time a space comes available, it’s probably going to be vacant for a few months before it’s rented again. It’s not the end of the world to lose 3-4 months between 5 year leases, but to lose 3-4 months between 1 year leases is a huge problem.
• Move in dates. Most New York leases start on the first of the month so the landlord can lose 0-30 days from the time of lease execution until the time they actually start getting rent. 20 days lost on a 7 year lease is insignificant, but on a one year term it matters. Keep in mind that there is also time spent negotiating the terms of the deal and reviewing the lease which can be another few weeks to few months depending on the size of the space.

I met with a small landlord a few months ago that had an interesting approach to short leases. He offers 1-5 year terms on all his spaces. He does not spend a penny fixing up the spaces (no paint or refinishing the concrete or hardwood floors in the building).

If you take a one year lease, you have to pay his legal bill. If you take a two year lease, you have to pay 1/2 of his legal bill. A three year lease or longer, he pays his own legal bill.

I found this interesting especially since it means that a one-year tenant is not going to spend the landlord’s time and money making excessive lease comments on a  one year term (since they’d be running up a bill on themselves). It was an interesting approach to accepting short term tenants.

As the tenant, if you had to spend $1,500 on your lawyer, $2,000 on the landlord’s lawyer, and $5,000 fixing up a small space that rents for $3,000 per month, wouldn’t you be more inclined to amortize those costs (especially if you could eliminate the legal fees).

Obviously, this doesn’t address all the typical objections, but certainly represents a compromise and creative thinking.

As an example:

• A landlord is looking to lease a space for $10,000 per month
• He spends $75,000 renovating it
• He spends $5,000 marketing it (floorplans, brochures, e-marketing, mailers)
• It’s vacant for 4 months
• He finds a tenant that negotiates the terms for 2 weeks and finishes executing the lease another 3 weeks later.
• The following first of the month is 17 days after the lease signing.
• He spends $2,000 in attorney fees

On a 5 year lease:

• He pays $36,000 commission (1 commission to the tenants broker, and half a commission to his broker), an average of $7,200 per year
• The out of pocket expenses ($82,000) average $16,400 per year
• The lost rent (6 months) averages to $12,000 per year
• His net is $120,000-$35,600 ($7,200 + $16,400 + $12,000) = $84,400 per year (plus escalations)

On a 1 year lease:

• He pays $9,000 commission
• $120,000 – ($9,000 commission + $82,000 out of pocket + $60,000 lost rent = $151,000)
• His net is negative $31,000!

To further exaggerate this, after 5 years (and 6 months)

• On a 5 year lease, the landlord will profit over $422,000 and save a lot of time and energy.
• By doing 4 one-year leases, the landlord will lose $124,000 and have to lease the space 4 times, a difference of over half a million dollars.

Of course, one year tenants can renew, alleviating this issue (and possibly saving them on the commissions) and some landlords don’t spend much renovating their spaces (and some spend more).

Either way,  it’s probably becoming clear why all these landlords are being so stubborn and inflexible about renting you their spaces for one year.

Eli

The tease of a below-market short term sublet (steal!)

One of the more popular requests I have been getting is for short term,  class a sublet space. The clear advantage here is receiving a tremendous value of paying sometimes less than half of what you should be paying for a space and getting the opportunity to rent it short term. Everyone feels smart cashing in on someone “desperate” situation trying to unload space they don’t need and it’s logically the way to get the most aggressive deal.

Of course, there are certain situations where this works out beautifully, but there are a lot of common problems that arise. To illustrate, here’s an experience I recently had.

I was referred a customer that was running a start up company well-funded by a billion dollar company and with principals with years of experience in the industry. They wanted a space with a couple offices and bullpen for about 40 for 1-2 years with a budget in the mid 30s.  The second most exciting prospect was a gorgeous Madison Avenue building that had a 2 year,  furnished, 5000 sf sublet willing to do a high 20′s deal (the most exciting prospect got taken off the market about a week after it was put on).

The existing tenant was paying north of $80 psf so that would be almost 1/3 the rent! This is great for the term of the lease, but if the subtenant holds over, they would be responsible for about $240 psf (about $100,000 per month), since the overtenant has a holdover clause requiring them to pay 3x the rent in the event of a holdover. In the high 20s psf, the sublease is only worth about $300,000. So if the subtenant holds over three months (or two months and one day), the overtenant is in the red. Plus they had to pay legal, brokerage and other expenses. It would take about 10 months security (at $11k per month) to even cover one day of holdover and good luck convincing a start-up to give that much deposit on a short term lease.

As is the case in a lot of these situations, the overtenant is a successful company that has outgrown the space. This means that even though they are losing money on the space and willing rent it for much less than it’s worth, they are not “desperate”. If they were really desperate and having problems, a) the company would probably default on the lease and the landlord would recapture it or b) you wouldn’t want to rent it from them since you would risk losing your sublease if they do go under.

Obviously, an overtenant is not willing to just hope that undertenant moves out in time risking $100k per month. If it’s not a company with a very strong track record, they won’t take the risk and well established companies are not usually looking for short term space. If one of the principals of the company would sign a personal guarantee or good guy guarantee, then they would take on that responsibility. But who wants to be personally on the hook for $100k if move-out isn’t timely? And not only that, the person signing would need to demonstrate pretty substantial funds in order for the overtenant to even be comfortable with them taking responsibility. Also, what if they pass away or leave the country?

If you are a well-established company looking for short term space (maybe for a project?), then a below market sublease is a great solution. If you are a start-up it can also be a tease. It might make more sense to take a sublet closer to market to avoid the draconian holdover penalty and at least give yourself the option for extending the lease after the term so you don’t need to move again right after the lease is up. Having the option to stay in your space after your lease is always a nice thing to have, but if your rent is going to double or triple, it’s not considered.

To capitalize on a really below market sublease, you must be a very strong company with an established track record in order to be approved.  Also, you will not be able to extend the lease at a similar rent (so effectively no option to renew or even stay an extra couple months). Finding a sublet more in-line with market is less tempting, but can often be a more practical solution.

Eli