(as reprinted from my interview with the Commercial Lease Law Insider, July 2019...an excellent publication and resource for understanding and negotiating lease clauses)
Before you go into negotiations with a prospective tenant, make sure you have a financial analysis of the proposed lease, so you can tie every added dollar of capital investment per square foot to an amortized x dollars at a certain interest rate over the lease term. This one-to-one correspondence allows you to make appropriate trade-offs, says Alice Devine, leasing consultant and award-winning author of Suite Deal: The Smart Landlord’s Guide to Leasing Real Estate (Learn Associates, 2019).
For example, $1.00 per square foot amortized over five years at a 5 percent interest rate equates to $.023 per square foot per year. So for every additional dollar contributed to tenant improvements (or other capital expenditures), the landlord would have to raise the rent by $0.23 per square foot per year. Understanding and calculating these numbers allows you to have an informed negotiation discussion, says Devine. She offers the following example from her book:
(As a note, real estate professionals often use the portable HP 12C calculator for easy amortization calculations. If you're new to the industry, run - or click - to the nearest store, and familiarize yourself with this indispensable tool.)
Assume the landlord has already proposed a rent including tenant improvements per an approved space plan. The conversation about lease terms might go something like this:
Tenant: I’d like to add glass sidelights to our offices and be sure our carpet is free of any adhesives or chemicals.
Landlord: I should mention that our building-standard carpet is installed over pad rather than with adhesive glue and that the new carpet will be aired out for several days via operable suite windows. Now, let’s talk about these proposed change orders. Say you choose to install Shaw’s Green with Envy carpet tiles; those will add $3,500 to our existing tenant improvement allowance. And if you want to buy three more sidelights, those total $3,500. We (the landlord) have the available funds, so if you want these upgrades, we can amortize this over your five-year lease term, and the rent will increase by $132 per month. Would you like to adjust the rent this way?
Tenant: We definitely want the sidelights (at $3,500). I guess the standard carpet is fine because of its good quality and installation.
Landlord: With the sidelights only, the rent increases by $66 month.
Tenant: We can live with that.
The same scenario applies to concessions with more free rent or other out-of-pocket expenses that are above the landlord’s pro forma rent and inducement package, says Devine. This quantifiable way of negotiating clarifies discussions so that additional capital costs correspond to rental hikes. By delineating and quantifying the choices and changes, the tenant and landlord make informed decisions.