Rent paid for office space can be one of the most significant costs of operating a business, yet it is often difficult to determine if you are paying too much or too little. This article provides a few tips to help you determine how much you should pay, as well as some advice on negotiating the rental provisions of your lease.
The rent you pay for the initial term of your office lease will be determined by the local real estate market. The best way to determine what the amount of that rent should be is to do some research before you negotiate your lease. Brokers can provide some of this information, but, since their commissions are often higher when tenants pay more, I do not recommend relying on brokers as your sole source of information on the prevailing rents in your area. For more objective information on rents, I usually turn to a website called LoopNet (See: “Why Your Office Space May Be More Expensive Than You Think”), but there are other similar websites that provide this kind of information, as well. Just remember that a website like LoopNet will give you an idea of the rents that landlords are asking, not the actual rents that tenants are paying, which may well be less. Consequently, I think of LoopNet as a good resource for determining the maximum, but not the minimum, rent that you should pay in a particular area.
In addition, when using LoopNet, make sure you pay attention to whether the rent quoted is per “rentable square foot” (usually abbreviated “per RSF”) or per “usable square foot” (usually abbreviated “per USF”). If you are considering space that will be leased at a rent per “rentable square foot,” and comparing it to LoopNet space leased at a rate per usable square foot, you are not comparing apples-to-apples. (For an explanation of the difference between “rentable” and “usable,” see “Why Your Office Space May Be More Expensive Than You Think.”)
When comparing rents, you should also factor in the cost of any build-out of the space that may be required. If the landlord will do some, or all of, a build-out, or if the landlord will give the tenant an allowance (usually called a “tenant improvement allowance” or “TIA”) that the tenant can use to build out the space, the landlord’s cost for the build-out or TIA is usually repaid to the landlord through a higher rent. If, on the other hand, the tenant will do the entire build-out, there is no build-out cost to be repaid to the landlord, and, as a result, the rent should be lower.
Finally, do not forget that real estate really is all about “location, location, location.” An office space in a highly desirable location will usually cost more than one in an out-of-the-way place, even if everything else about the two spaces is the same. Similarly, rents differ based on the quality of the building in which a space is located. An office space in a state-of-the-art, new office building will usually cost more than one in an aging strip mall, even if the two buildings are right next to each other.
Annual Rent Increases.
Annual rent increases are determined by local market forces, just as initial rent is, but it is difficult to find good information on the Internet about the going rate of annual rent increases. In any market, however, you should not assume that rent automatically goes up every year. In the current, soft, real estate market, for example, I have found that many landlords in my area will agree to little or no rent increase over the entire initial term of an office lease, especially if that initial term is only five years long. In the alternative, landlords will sometimes agree to an increase every other year, rather than every year, or just one increase, about half-way through the initial term. The best way for you to test the boundaries of what is attainable, with respect to annual rent increases, is through the negotiation process. Just remember, landlords are almost always willing to accept less than they initially request, so it is worth your time to negotiate, not just the initial rent, but also the amount, if any, by which it will increase each year.
For option terms, you should make sure that the amount of rent payable is either a fixed amount, set at the time you sign the lease (for example, $20.00 per rentable square foot), or a fixed amount that will be determined by a reasonable formula (for example, 105% of the annual rent payable during the initial term or an adjustment based on the consumer price index). Do not agree to an option to renew your lease at “current market rates,” without any formula for determining what that means. Such open-ended language will force you to negotiate the amount of rent payable during the option term at the time of renewal. If your dental practice is doing very well, and you really want to stay in your current location, your landlord will use these facts against you, when you negotiate the renewal term rent, and you may well end up paying too much rent, just so you can keep your space. If, on the other hand, you have agreed on the rent payable during the renewal term, when you sign the lease, you will be certain that you will be able to stay in your space, if you choose to do so.
What if you agree on the renewal term rent, when you sign the lease, and rents, subsequently, drop dramatically? In that case, remember that you can always try to renegotiate the renewal term rent before you exercise your option. Landlords are often open to such a renegotiation because they cannot force you to renew your lease. In order to keep you as a tenant, your landlord may be willing to agree to lower the agreed rent for the renewal term.
A very important, but sometimes overlooked issue, when negotiating rents, is the date on which payment of rent begins. Most office tenants do not pay base rent or common area expenses while their space is being built out, and they often enjoy an additional “free-rent” period, even after the build-out, of anywhere from one to six months (sometimes even longer), depending on local market conditions. When negotiating an office lease, at the very least, you should make sure that you do not pay rent until you open for business in the premises, if the landlord is doing the build-out. If you are doing the build-out, the landlord will want to protect itself from the risk that you will not complete the build-out in a reasonable time, so, in that case, the rent commencement date is usually the earlier of the date you open for business or a certain number of days after the lease is signed, with the number of days determined by the anticipated length of the build-out. In addition to this rent abatement during the build-out, you should also try to negotiate an additional “free-rent” period that begins after that and continues for as long as possible.
This article was written by Janice L. Gauthier, Esq. Ms. Gauthier has an A.B. from Harvard University and a J.D. from Harvard Law School. She is the owner of The Gauthier Law Group, LLC, a boutique law firm that represents dentists, physicians, health care providers, professional service practices and other businesses and business owners in Wisconsin and Illinois. You can contact Ms. Gauthier at 414-270-3857 or by email. To learn more about Ms. Gauthier’s background and experience, visit her Google or LinkedIn profiles.
© 2012, 2013 The Gauthier Law Group, LLC
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