Sometimes New York City landlords will consider giving a tenant a “cancellation clause” or “early termination option”.
Most of the time there will be a penalty attached to this option. Since a landlord is justifying the costs of renting a space by spreading the expense over the course of the lease, if the lease ends up being shorter, they would want to recover the appropriate portion of those costs.
The cancellation clause usually holds the tenant responsible for unamortized costs of buildout, brokerage commission, and rent concession and is typically only possible to be exercised on a given date, but sometimes any time after a certain date with a certain amount of notice.
The basic calculation is as follows:
Landlords Total Costs (Cost to build the space + Rent concession)
Divided by the lease term
Multiplied by the amount of time remaining on the lease at the time of termination
Plus the brokerage commission appropriated for the remainder of the lease
Here is an example:
The space is $10,000 per month and the tenant signs a 10 year lease with a cancellation clause after 5 years and receives 3 months of free rent. The landlord spends $120,000 to build the space.
Landlords Total Costs ($120,000 + $30,000) = $150,000
Divided by lease term (10 years) = $15,000
Multiplied by the amount of time remaining (5 years) = $75,000
Plus the brokerage commission appropriated for the remainder of the lease (~$15,000) = $90,000.
Obviously, the less the landlord spends on the buildout, the less rent concession given, and the less time left on the lease, the less the termination penalty will cost.
Also, if your broker is willing to defer payment of the last portion of their commission and only conditionally accept payment if you do not exercise your termination clause, then you can eliminate that portion of the cost.
Depending on what condition the market is in at the time of the termination, there's a good chance it will be easier and more cost effective to sublet the space than exercise the cancellation clause, but it's still good to have in case the market tanks or just as a worst case scenario back up plan.
In rare situations, there will not be a penalty for a termination option (typically if they are not doing any build-out, giving any free rent, and they are only paying brokers if the option is not exercised).
Escalations typically refer to annual increases the landlord charges to account for the rise in operating expenses, inflation, market increases, and profit.
A standard Manhattan escalation is 3% per year, but can sometimes be negotiated especially in a soft market. Certain landlords will ask for higher escalations (4-5%) and in certain instances I've seen a landlord charge a 4% increase, but not hold a tenant responsible for their proportionate share of real estate tax increases. So in that case, the tenant is probably better off.
On a longer lease, there is typically a bump, in addition to an escalation, around the 5-7th year.
Certain landlords won't require a fixed increase, but will instead adjust the lease annually according to the consumer price index (inflation). This is less predictable and not necessarily worse (depending on how the economy is), but is more dangerous. For example, if inflation spikes tremendously (e.g. 8%) in the second year of a ten year lease, you are suffering the consequences for the rest of the lease.
If a landlord requires CPI instead of a fixed increase, I usually suggest having the CPI limited or capped to for example, 5% (but obviously, the lower the better).
Buildings usually add charges to base rent. The primary additional charge is electricity.
This is billed in one of three ways:
1) Direct – You pay your own electric bill (this is usually the most desirable)
2) Submetered – there’s a meter in your space that belongs to the building (not the electric company) and they send you an electric bill along with your rent every month. They will often add a surcharge for this (for example: 5-10% on top of your usage)
3) Per square foot/per year: this is usually between $3 and $3.50 per square foot per year regardless of your usage. For example, in a 1000 sf space with the electric at $3.50 psf, the monthly electric charge would be:
$3,500 per year/12 (months) = $291
Other charges tenants are frequently held responsible for are water, sprinkler, sewer doorman, security guard, and garbage removal. These are usually billed as flat monthly charges.
For example, a 2000 sf office could have a $40 water and a $40 sprinkler monthly charge and the tenant would have to pay the refuse removal company $30 per month for their services
Landlords need to see financial information from prospective tenants to determine if they want them in their buildings. The stronger a tenant is financially, the more attractive they are to the landlord. Typically, if all other aspects are equal, landlords will choose the tenant that is stronger financially. If a potential tenant doesn’t have financials that are appropriate for the price space they want, a landlord will either: reject the tenant or ask for a personal guarantee.
Landlords also use a tenant’s financials to determine the security deposit they will require for the lease.
The standard documentation requested is the first 3 pages of the last 2 years of the company’s tax returns. If the company is a start-up or the tax returns are not a good indicator of the company’s standing, a prospective tenant should include other information such as bank statements and statements certified by their accountants such as profit/loss, summary of assets, etc. (basically anything that is evidence you are a strong company).
An important factor for a landlord to consider is how many people are going to be visiting the prospective tenant. At first, some tenants may not realize why this would be a concern for a landlord.
Even traditionally prestigious medical users are turned away by most buildings because of the amount of patients visiting them.
The primary issue is the negative effect a lot of people coming to the building have on the elevators. For most landlords it’s not worth inconveniencing (and potentially losing) the rest of their tenants to pick up a high foot traffic tenant. Most people are not happy waiting several minutes for an elevator and having to squeeze in there with a bunch of other tenants for multiple stops before it gets to the lobby or their floor.
Sometimes landlords will be more flexible on high-traffic users if the traffic occurs during off hours (like a college that teaches a class at 7 PM or on Saturdays).
Each landlord is different and some are much more open to considering high traffic users. This is one reason why you’ll see a lot of doctors in the same building (that and plumbing access to small spaces).
Somewhat ironically, the buildings with the largest elevator problems are the ones that are most likely to accept high-traffic tenants. Since the owners that are open to considering tenants with a lot of visitors already have accepted other tenants with high-traffic visitors, sometimes the buildings with the most crowded elevators are most willing to exacerbate the problem.
Obviously, this can be more of an issue for tenants with visitors since their visitors/customers will get annoyed by the inconvenience.
Often a good solution for a high foot traffic tenant is a walk-up building, lower level space, or 2ndor 3rd floor space in a smaller building where there isn’t as much of a disruption on the other tenants. Retail spaces are also an option, but come at a higher pricepoint.
If you’re a high foot traffic tenant, your options will be much more limited than a standard office use like an accountant or hedge fund.
If you are one of the following businesses, landlords are likely going to be asking you a lot of questions about the amount of visitors you will have:
- Doctor or dentist
- Hair salon
- Modeling agency (casting calls)
- Physical trainer
- Teaching facility/classroom
- Real estate office
- Fashion designer (sample sales)
- Dance studio
- Yoga Studio
In New York City, landlords typically pay commercial brokerage commissions. If a tenant is ever looking to sublease their space, they should expect to pay a full brokerage commission unless they find someone to rent the space on their own.
It is expected that the outside/tenant's broker receives one full commission (100%) and the landlord's broker receives one half commission (50%). One full commission is typically calculated as follows:
Year 1 - 5%
Year 2 - 4%
Year 3 - 4%
Year 4 - 3%
Year 5 - 3%
Years 6-10 - 2.5% each
Each brokerage firm can have a different schedule, but they are usually a variation of the above schedule. Commission is usually paid on base rent only, not annual escalations. So for example, the commission on a 5 year lease is equivalent to 19% of one year for the outside broker and 9.5% of one year to the representing broker.
There are some brokers that will offer commercial spaces on a reduced commission basis, but most tenant brokers, especially good ones, will not take their tenants to properties that don't pay full commissions. Basically, if there are 5 properties that match their tenant's criteria and 4 of them are paying twice as much commission as the "cobroke" listing, why would the tenant's broker show the property that is only paying them half the amount?
If the landlord's (or overtenant's) broker finds a tenant without the assistance of the outside broker, then they receive one full commission.
Good Guy Clause
A good guy clause is a limited personal guarantee. The distinction between a good guy clause and a traditional/full personal guarantee is that in a good guy clause an individual’s personal liability ends when the space is vacated. Therefore, if a company dissolves and the space is vacated, the individual is absolved of any further responsibility.
Good guy clauses evolved as a compromise between landlords and tenants in New York City and are now a standard component of commercial leases in Manhattan. Good guy clauses usually, but not always, contain notice provisions (between 30 and 180 days) that can sometimes be negotiated.
Landlords were having problems with companies going bankrupt, defaulting on their rent payments, and not surrendering the spaces. The eviction process can be very extensive and typically takes about 6 months.
In order for a landlord to feel secure they had wanted either 6 months security deposit or a personal guarantee from the tenant.
A good guy clause basically states that if a company defaults (for bankruptcy or any other reason), the individual that signed the good guy clause is responsible for the rent in between the default date and the surrender date (when the space is vacated). This way, if the company goes bankrupt, the tenant still has an incentive to vacate the space, but is not responsible for the remainder of the lease if they cooperate and "be a good guy".
For example, if Company X stops paying rent June 1 and Company X leaves June 1, the good guy is completely off the hook.
If Company X stops paying rent June 1 and Company X leaves July 1, the good guy owes the landlord rent for the month of June.
Sample Good Guy Clause -
The undersigned hereby covenants and agrees that if there shall occur any default by Tenant in the payment of fixed rent or additional rent or any other charges set forth in the Lease, or if Tenant shall default in the performance of any of the covenants, terms, conditions and agreements contained in the Lease then the undersigned shall in each and every instance up to and including the Release Date (as defined below) (i) pay such fixed rent, additional rent and any other charges due and payable by Tenant to Landlord (ii) faithfully perform and fulfill all of such covenants, terms, conditions and agreements to be performed by Tenant as set forth in the Lease, and (iii) pay to Landlord all consequential damages that may be incurred by Landlord as the result of any default by Tenant under the Lease including without limitation all attorneys' fees and disbursements incurred by Landlord as a result of any such default and/or the enforcement of any of the provisions of the Good Guy Clause. The "Release Date" shall mean the upon which Tenant returns to the Landlord the keys to the Premises and surrenders possession of the Premises in the condition required by the Lease as of the expiration or termination thereof free of all tenancies or rights or claims of occupancy by Tenant or any party claiming through Tenant.
A Holdover clause is common in a commercial lease. Basically it states that if the tenant does not vacate the space until after the termination date, they are responsible for a specific amount of additional rent. A holdover penalty is usually between 2 and 3 times the last (escalated) rent.
At first glance it seems like a high number, but keep in mind that it's hard to predict the real estate market. If a tenant signs a 10 year lease starting at $10,000 per month with 3% escalations, they will be paying about $13,000 per month at the end of the lease. If the real estate market has gone up 60% over those ten years (certainly not unprecedented), the tenant could stay in the space on a month-to-month basis at a below market rent indefinitely.
It's not unusual for a landlord and tenant to extend a lease for a few months after a lease for a rent that they both think is fair, but if the holdover penalty does not exist, the landlord is put in a bad position since the tenant has less of an incentive to be proactive or communicative about extensions.
The holdover penalty is also high primarily to discourage holding over and encourage tenants to be communicate if they need extra time, not to generate more profits for the landlord.
If one tenant's lease ends on September 30, and there's a prospective tenant that wants to sign a lease on the space for November 1, the landlord needs to be certain the outgoing tenant moves out on time or at minimum, tells him that they are not.
Holdover clauses can garner extra attention on below-market subleases.
Below is an example of a holdover clause:
In the event Tenant remains in possession of the Demised Premises after the termination of this Lease, Tenant, at the option of Owner, shall be deemed to be occupying the Demised Premises as a tenant from month-to-month, at a monthly rental equal to 200% of the sum of (a) the monthly installment of Fixed Rent payable during the last month of the term and (b) one-twelfth (1/12th) of the Additional Rent payable during the last year of the term, subject to all of the other terms of this Lease insofar as the same are applicable to a month-to-month tenancy.
If you are new to New York City commercial leasing , it can be helpful to refer to the dropdown menu above to familiarize yourself with common terminology used when leasing an office in Manhattan.
If there's any terms you are unfamiliar with that aren't included, please don't hesitate to contact us with any questions.
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.
Once a landlord and a prospective tenant have agreed to terms, the landlord will draft a lease a send it to the tenant to review, make changes (to the legal terms, not business points), and execute. This process can be immediate or can take months depending on the simplicity of the deal and how quickly the landlord, tenant, and their attorneys act.
On a straightforward deal for a relatively small space, the landlord will expect the tenant to sign the leases within a week or two. The landlord will be more patient if the tenant is actively asking questions or making changes to the lease than if they are unresponsive for a week and a half.
Typically, when a landlord will only send one tenant a lease at a time and will not entertain other offers while they are waiting for the signature. However, if the tenant is unresponsive or attempting to renegotiate the business terms, the landlord may revert to back up offers or encourage other tenants to look at the space.
If you are looking for space and your desired space has a lease out for signature, you are basically on hold. Sometimes tenants or landlords have a change of heart and it doesn't work out, but it's hard to predict how long it will take to know. The tenant with the lease can walk away from the deal the next day or drag it out for another three weeks then sign.
The best way to approach the landlord if you want a space that has a lease out is to send a strong offer to the owner and tell ownership that you are ready to move forward asap if there is a snag in the negotiations with the tenant with the lease. I would also send them reminders that you are still interested about once a week. This serves a couple functions:
- Let ownership know an attractive deal is on the table if they are having difficulty with the existing tenant. The landlord is more likely to reconsider taking a deal off the table with another tenant if they know they have something else to go with (rather than no one else interested)
- Keeps you fresh in their mind and let them know you are serious. Sending a commitment along with information about your company is different than having your broker ask them to let you know if something changes.
- If there are a couple people watching the lease hoping it doesn't work out, having your offer ready to go gives you an advantage on other interested parties. The owner will probably contact you first if there's an issue with their current deal.
Loss factors are calculated by subtracting the usable area from the gross/rentable area and dividing by the rentable area. (Rentable SF - Usable SF)/Rentable SF = Loss Factor.
Loss factors and usable sf are typically not disclosed by landlords.
The gross or rentable sf (before loss factor) is always the square footage advertised on a Manhattan office space.
The following gives a great background on loss factors.
LOSS FACTORS ARTICLE
Once upon a time, many years ago when twelve inch rulers were inflexible, a hypothetical New York City landlord stood in the vast 10,000 square foot hypothetical lobby of his eleven story hypothetical office building, watching his hypothetical tenants arrive for work in the morning.
The landlord had successfully leased the second through the eleventh floors to ten tenants, each occupying 10,000 square feet. As the landlord stood in his lobby that day, considering the rental revenue his building was generating, it occurred to him that even though each of his ten tenants was paying rent based on 10,000 square feet, no one was paying him rent for his beautiful lobby even though every tenant walked through it at least twice a day.
Nothing if not an opportunist, the landlord decided that when he built his next building, he would tell each incoming tenant that the rentable area on each office floor was 11,000 square feet, even though each floor would actually contain 10,000 square feet. If anyone challenged him on his measurement, he would explain that since each tenant uses his lobby, each tenant must pay for its proportionate share of that common area.
And that is how Loss Factors were made ...
Well, maybe that's not exactly how it happened, but it is true that at one time, there was a rational explanation for why New York City landlords insist tenants pay rent per square foot for space tenants don't really occupy. (1)
Fast forward to today and Loss Factors have become a market driven business term, as relevant to tenants as rent, free rent and tenant improvement allowances.
Whenever a commercial landlord decides to sell an office building in the current climate (an extremely competitive, heavily picked-over sales market where $13.1 billion dollars worth of commercial property was sold in Manhattan in 2005 (2)), the first action taken by his sales agent is to increase the full floor Loss Factor to 25%.
Buyers of commercial property, particularly buyers of Manhattan trophy office buildings, generally don't question 25% full floor Loss Factors notwithstanding the fact that Manhattan office buildings come in all shapes and sizes with vastly different floor plate configurations, load bearing column density, width of perimeter HVAC convectors convector: see heating.
..... Click the link for more information., etc. Imposing a 25% full floor Loss Factor on an inefficient floor plate translates into asking a tenant to pay rent for a lot of inefficient square feet.
So you may be thinking to yourself, okay, a 25% full floor Loss Factor means that tenants actually occupy 75% of the rentable area in a recently sold Manhattan office building, right? Well, no, that's not really right. To understand how to measure and define office space in New York City one must first understand terminology.
"Rentable Area" represents the number of square feet based on which office tenants pay annual rent per square foot. Every landlord advertises vacant space based on Rentable Area but Rentable Area is only an approximation of the size of the premises.
The term "Usable Area", as it's commonly used in the NYC commercial real estate market, is essentially a misnomer. The Real Estate Board of New York (REBNY) guidelines for determining Usable Area were most recently updated in 1987 and recommend that landlords calculate Usable Area by measuring the entire floor to the outer facade of the building (often beyond the window line) and deducting only floor penetrations (e.g. elevator shafts, fire stairs, risers, etc.). According to REBNY guidelines, on a full floor basis, Usable Area includes electrical closets, fan rooms servicing the floor, janitorial rooms, bathrooms, load bearing columns and space occupied by perimeter convectors.
Loss Factors are the difference between Rentable Area and REBNY Usable Area (3).
Two other synonymous terms commonly used are "Carpetable Area" and "Assignable Area". These terms literally refer to the number of square feet on which a tenant can lay carpet.
On a divided floor landlords apportion common area hallways, bathrooms, electrical closets, slop sinks, fan rooms, etc. to the point where divided floor Loss Factors often rise well above 35% and Carpetable Area can be less than half of the Rentable Area.
So the market has all these terms for quantifying office space, some of which are more than a little misleading. What should tenants be aware of? Certainly, tenants should care a great deal about how much Carpetable Area exists in a certain premises since Carpetable Area correlates directly to how many bodies can fit into a certain space. Rentable Area is crucial too since the number of rentable square feet correlates directly to the annual (and monthly) rent.
Tenants should be aware of Loss Factors and floor plate efficiency. Tenants would be wise to confirm that a Loss Factor in a certain building is consistent with market Loss Factors. (This can be established by having the tenant's architect compare CAD drawings from comparable buildings.) However, in the final analysis, tenants should concentrate mainly on how many people a certain space can accommodate and what the rent is going to be every month, Loss Factors notwithstanding. This is especially true since once it's been established that a landlord is not pushing the Loss Factor envelope farther than his neighbors, challenging his methodology for measuring office space is like pushing a string. One silver lining is that landlords provide tenant improvement allowances based on Rentable Area while contractors tend to submit construction bids based on actual costs of construction, irrespective of Loss Factors. In terms of tenant improvement allowances, one could argue that tenants actually benefit from a high Loss Factor.
In defense of landlords, I recall one situation in the mid 1980's when an owner refused to apply a Loss Factor to his vacant floors. Instead, he asked for a higher rent per square foot arguing that without a Loss Factor, his space was still less expensive than space being offered by competing landlords imposing high Loss Factors. Mathematically, he was correct. But tenants and many brokers didn't appreciate his logic and his space remained vacant until he applied a Loss Factor and lowered his asking rent.
The New York City commercial real estate market, like all financial markets, is susceptible to herd mentalities. As long as most landlords uniformly apply high Loss Factors, tenants' only option is to fight their way up the learning curve and understand NYC Loss Factors for what they are: a market driven phenomenon.
1) Some say the genesis of Loss Factors has more to do with the advent of central air conditioning and the transition from floor by floor air cooled air conditioning units to HVAC mechanical equipment on roofs or designated mechanical floors, causing landlords to apportion mechanical space to tenants' Rentable Areas.
2) According to Real Capital
Wealth that can be represented in financial terms, such as savings account balances, financial securities, and real estate. Analytics, the following statistics apply to 2005 sales of Manhattan commercial properties worth a minimum of $5 million: $13.1 billion of total sales, 138 properties, 30.6 million square feet, $426 average price per square foot, 5.24% average cap rate.
3 (Rentable Area less Usable Area) divided by Rentable Area equals the Loss Factor.
By David L Hoffman, JR
Executive Managing Director, Colliers ABR, Inc
Short for "New Building Installation", this refers to when a landlord is providing a new build-out on a space for an incoming tenant.
If a tenant decides to rent a space, the first step forwards is submitting a proposal or offer. The proposal should include:
Your broker can draft the offer and you can review it before they submit the offer to ownership. All offers should be non-binding . Unless time is of the essence or there is competition for the space, it is usually smart to send an initial offer that is a little too low to be accepted, but high enough to be seriously considered and garner a counterproposal.
There can be several rounds of counterproposals before an agreement is reached.
A “prebuild” or prebuilt space is a space that a landlord has renovated and built out in order to make it more appealing and readily available to a prospective tenant.
Typically vacant spaces will remain in the condition the previous tenant leaves them. Once ownership receives an offer, the tenant will either request work to be done to the space, ask for free rent or a cash allowance (or “TI”) to do their own work, or move into the space as-is.
The advantages of the traditional approach is that ownership can build the space exactly how the tenant wants it and ownership doesn’t spend any money in the meantime. The advantage to the tenant is they can get the space exactly how they want it.
There are a couple reasons an owner would prebuild a space:
- So it shows better. It’s one thing to tell a tenant how a space could look, it’s another thing to update it with high end finishes and eliminate the need for anyone to use their imagination (or architect).
- To cater to tenants needing immediate occupancy. If a tenant needs space in two weeks, they are not going to be able to wait for an owner to do a full build-out. This gives a prebuilt space a competitive advantage for tenants that need space asap (who often have a stronger sense of urgency and are more motivated to make a deal)
- To make efficient use of time. While a landlord’s space is vacant and they are waiting for a tenant, if they use that time to renovate the space, they might not actually be “losing” that time, if it reduces the time it takes from lease signing to tenant occupancy.
- Achieve higher rents. Landlords can typically get higher rents on prebuilt spaces since they look better (wouldn’t you pay more for mint, restored car than an old broken car of the same year that the seller promises to fix up?)
- Rent the space faster. Using the same car example, wouldn’t the restored car sell a lot quicker?
Reasons not to prebuild a space:
- Save on out of pocket expense. Even though a landlord might (or in some cases probably will) need to build the space for a tenant later, they are less motivated to spend the money without anyone willing to pay rent as soon as it’s completed.
- What if the incoming tenant is not that picky and doesn’t need high end finishes?
- Less flexibility. What if the incoming tenant wants a different layout than you spent money building? If you just built 6 glass offices and the incoming tenant wants a wide open space for their trading desks, you are either turning away a tenant or wasting all the money you spent building those offices. A less extreme example would be if you built 6 offices and the tenant only wanted 4.
Proportionate Share of Real Estate Tax Increases
New York City real estate taxes are assessed every July. Each building is assessed a different tax every year. Sometimes the tax on a building does not go up, but it usually does. Landlords can’t predict how much their real estate tax will increase so they pass along the charge to their tenants.
As an example, a tenant occupies 5000 sf in a 250,000 sf building. Their proportionate share of the real estate tax increase would be 2%. If the base tax year is 2008/2009 (July to July) and real estate taxes in the building increase $10,000 in July 2009, the tenant would pay/reimburse the landlord $200 (2% of $10,000). It is not uncommon for a landlord to spread out these payments and charge the tenant in monthly installments instead of one lump sum (especially if it’s a high increase).
It is important to keep in mind that tenants are responsible for the increases above their base year, not the previous year. Using our past example of the $200 tenant charge in July 2009, if in July 2010, the real estate tax on the building increases $20,000, the tenant would now owe $600 in 2010 ($200 + $400 because the real estate tax is $60,000 more than it was in the base year 2008/2009).
So if there is a high increase in the second year of a five year lease, the tenant will also be enduring the effects of that in every year following.
Landlords also sometimes hold tenants responsible for increases in fuel charge, which works the same way, but is typically a much less substantial amount.
Landlords usually will require tenants to accept the current tax year as the base until it is completely over. But if, for example, you are negotiating a lease that begins in June 2009, you should at least try to negotiate a base tax year of 2009/2010 (since the 2008/2009 tax year is almost over). This will not only help you avoid paying your share of the increase at the beginning of the lease, but the result of that increase every year afterwards.
Otherwise referred to as "free rent", the rent concession is a period of rent abatement given to an incoming tenant. Rent concession are most often awarded to tenants when a space needs considerable work and the landlord is not renovating it, but providing a rent concession to help the tenant offset the construction costs.
However, it is not uncommon for landlords to offer a rent concession on built spaces as an incentive for tenants to rent space from them. Like rent prices, rent concessions given are heavily influenced by the state of real estate market.
On a given space, you can usually get more free rent on a longer lease. Short leases typically do not provide any free rent period unless there is considerable work that needs to be done to the space.
A sublease is when a tenant (overtenant) rents their space, or part of their space, to another tenant (undertenant). Typically a sublease is for the entire period of time remaining in the overtenant's lease, but can be shorter. Extensions can also be negotiated between the undertenant and landlord, especially if there is relatively short amount of time left on the sublease term.
Subleases must always be subject to the terms of the master lease between the overtenant and landlord. These terms cannot be changed, but the undertenant can, and should request a copy of the master lease to review as part of their due diligence.
Subleases are more common than assignments because in an assignment, the landlord absolves the overtenant of any responsibility. In a sublease, the landlord is still entitled to the rent from the overtenant even if the undertenant is not paying.
Here are some differences between leases and subleases:
- Subleases are usually not flexible on term. For example, if there are 26 months left on a lease, that will be the only possible term the overtenant will consider. They will not consider a 24 month term since it's very unlikely (and difficult) to find another undertenant for the last two months. They won't consider a 36 month term since they are unable to sublease the space for a longer term than they have the rights to the space.
- Subleases are almost always leased in as-is condition. Landlords will often do some renovations as part of a deal with a new tenant. Overtenants are usually not interested in the responsibility of construction work and are not as well-equipped to do it. In certain situations, especially if the space is not in move-in condition, undertenants can negotiate a substantial rent concession in exchange for sparing the overtenant from doing any work.
- Subleases are more often furnished than direct leases. This is because the existing tenant is (or was recently) operating out of the space, no longer needs or wants it, and therefore may no longer need or want the furniture that's in it. Although new furniture can be expensive, it is difficult and not very lucrative to sell used furniture so if it can provide an incentive for an incoming undertenant, the overtenant is usually willing to give the furniture away with the space.
- Subleases can often require higher security deposits than direct leases. One important reason is to protect an overtenant from a subtenant defaulting with a very short term on the lease. For example, if an undertenant defaults with 10 months left on the term, the overtenant is most likely out of luck for the 10 months (whereas, if it was a direct lease, the landlord could lease it for any term length once the tenant defaulted). Another important reason is a holdover clause. Since most leases have a holdover clause that keeps a tenant responsible for 2-3 times the rent if they holdover, an overtenant needs to protect themselves from an undertenant overstaying their welcome and the landlord charging them as a result. This is especially important in a below-market sublease since the overtenant is being charged holdover rents on their higher rent, rather than the undertenant's discounted rent.
and clarification on some common misconceptions about subleases:
- Subleases are cheaper than regular leases. This is true in some cases, but not always the case, especially if the subleases have an above-standard installation and if the market has picked up since the overtenant signed their lease.
- In a sublease, you pay the overtenant the same amount they are paying the landlord. An overtenant has the right to charge any amount more or less than the rate they are paying. They often will not reveal the amount they are paying the landlord and an undertenant is not entitled to know the rent an overtenant pays (but sometimes will know).
- Subleases are usually from companies that are desperate and about to go out of business. If a company is in bleak condition, they will typically dissolve and break the lease rather than sublease. It's also risky for an undertenant to sublease from a shaky overtenant because if they overtenant defaults, the undertenant's office is now in jeopardy and subject to the landlord's discretion. Often, subleases are from companies that have outgrown their spaces (and are doing very well).
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.
Leasing an office in Manhattan can be overwhelming, but by working with an experienced, knowledgeable and reliable agent that prepares you for what to expect, it facilitates the process.
You can also access the dropdown menu above for explanations or solutions to common problems encountered when renting an office in New York.
Here is a quick summary of the commercial leasing process:
STEP 1: Identifying Your Needs
This includes determining how many square feet you need, your desired layout, lease term (standard is usually 3-5 or 5-10 years), and budget along with cosmetic factors like flooring, ceiling height, and natural light.
STEP 2: Gathering/Preparing Financial Information
Before being accepted by a landlord, the landlord will need to review your company financial information. If you have it together before you find your space, it will make it easier to secure the space.
STEP 3: Finding Your Space
Some people know what they want immediately and others are more comfortable seeing enough spaces to get an understanding of the market first. As a potential renter, you can work independently or use a broker. Since commissions in commercial real estate are paid by landlords, using a broker usually will not cost you anything.
STEP 4: Submitting an Offer
Regardless of how long it takes you to find your space, it's critical not to hesitate once you do. Since commercial space is in high demand in New York, your window of opportunity is usually not very big. Some spaces sit on the market for months or even years, but the most desirable ones are often leased within a few days.
If you have already prepared your financial information, you will have saved crucial time and gained an advantage over another interested tenant that has not.
STEP 5: Negotiating Terms & Getting a Lease
If your initial offer is not accepted, the landlord will usually send you a counteroffer and you can begin negotiating the terms such as rental rate, free rent, landlord work, and length of lease. Once the terms have been agreed upon, the landlord will send you a lease.
STEP 6: Signing A Lease
Once you receive a lease, you can review it yourself or hire an attorney to review it. If you have questions you can either ask the landlord's representative, your attorney, or your broker. You can ask the landlord to make changes to some of the lease items, but they will not revisit any of the terms already discussed during negotiations. Typically landlords will give a tenant a week to review a lease before they expect it returned signed with the deposit and first month's rent checks.
As commercial real estate brokers, our goal is to help find you the right office for the right price. We believe that the more straightforward you are with your clients, the better results you can achieve together. At living, we take pictures of almost any space we see so we can share them with our clients before showing the spaces. This allows us to narrow down which spaces you want to see more accurately and also saves a lot of time for our clients and ourselves. We are also committed to responding very quickly to our clients anytime day or night.
We have access to every commercial space in New York City and our information is updated daily so we always know everything that is available.
What If I Outgrow My Space?
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.
- 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!
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.
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.