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  On the other side of the coin, any environmental hazards must be understood and disclosed in the marketing process. Items such as asbestos or groundwater contamination are of major interest to most corporate tenants and can stop a deal in its tracks. Because of the legalities and exposure (no pun intended) associated with these issues, it’s best to consult your legal counsel.

  Green, by LEED

  Established in 1992, the US Green Building Council (USGBC) offers the LEED (Leadership in Energy and Environmental Design) certification, the industry yardstick of green construction and practices. When a building wears a LEED plaque on its exterior, it indicates that the property meets a complicated set of sustainability criteria. Certifications range from the highest-level platinum to gold to silver. In addition, contractors can earn LEED certification for their environmental practices. Because LEED certification is costly and time consuming, some landlords prefer to adopt and advertise green practices while forgoing a formal designation.

  Establish Competitive Lease Terms

  A building’s value is calculated based on its assured rental income stream. For an existing building, leasing professionals study the rent roll—the summary of all the leases in the building—that lists tenants and their square footage, location, rent, lease expiration date, and encumbrances (such as a right to expand or a right to renew) that may burden other spaces in the property, in order to gain perspective on a property’s leasing status. The rent roll reveals how much of the building is leased, to whom, and at what rates, while also exposing vacancies and space vulnerabilities such as several leases expiring at the same time. Also, a holistic look at the building gives you information about market rental rates and typical tenant sizes for your property.

  For both occupied and vacant buildings, creating the right mix of tenants, carving vacant spaces into leasable chunks, setting term lengths, and establishing rent and other improvement allowances all require a delicate balance. While each landlord’s particular ownership goals will guide decisions with regard to the final terms of a given lease, there are common components of the central business terms of most leases.

  Tenant Mix

  A complementary tenant mix can both attract businesses to particular buildings and, once there, help them flourish. For instance, a medical building’s marketing plan might target physicians, dentists, laboratories, radiologists, and a pharmacy. A more generic office building within blocks of the train station and close to restaurants and bars might appeal to technology firms with employees that use public transit. And an iconic property such as San Francisco’s Transamerica Pyramid may attract a veritable Who’s Who of investment firms, law firms, banks, and venture capitalists. Good landlords cultivate a tenant mix that supports the financial well-being of their tenants. After all, healthy tenants make for rent-collecting landlords. It is thus essential to define the optimal tenant mix for the property, paying attention to the companies that populate the market.

  The flip side of the tenant mix equation is occupants who detract from others’ experiences at the property. Be wary of leasing to tenants who use a disproportionate amount of resources at the expense of others. For instance, the tenant who monopolizes the freight elevator with frequent deliveries will irritate the tenants who want easy elevator access for their clients. While specific businesses such as a restaurant may insist on a non-compete clause within the property, most tenants leave this issue of appropriate tenant mix to the landlord’s judgment. Again, as a practical matter, intelligent landlords consider the well-being of their existing tenants before leasing to companies that might cannibalize those tenants’ businesses and jeopardize their ability to pay rent. In addition, leasing a majority of building space to tenants in a particular industry sector may make a building more susceptible. For example, buildings largely leased to finance companies, mortgage brokers, and so on experienced greater vacancy and bankruptcy proceedings during the economic downturn of the past decade than did buildings with highly diversified tenant rosters.

  Suite Size

  Deciding how (or if) to carve vacant space into leasable suites requires balancing factors such as market demand, the building’s design, and the owner’s willingness to accept the vulnerability of one or more concurrent lease expirations. Offering spaces in particular sizes can be a Rubik’s Cube of planning, with the realities of daily leasing and market demand upending even the best-laid plans.

  There is a relationship between suite size and term length. In order to assemble large blocks of leasable space, you need expiration dates to coincide or you need to negotiate a relocation clause for existing tenants so you can accommodate large or expanding companies. For example, suppose you have Tenant A with 15,000 square feet adjacent to Tenant B with 3,000 square feet. In order to assure maximum flexibility for the larger tenant that might need more space, a landlord might want to keep the smaller tenant’s lease term coincidental with the larger tenant’s or, at minimum, obtain a relocation clause. A relocation clause, if exercised, can be expensive (and create unhappiness on the part of the relocated tenant), so many landlords consider it a last resort even though they often have this (relocation) clause in their standard lease forms. So it’s not that landlords will not exercise this right, generally they just prefer to avoid it. Some owners prefer to carve up one floor for smaller tenants and retain larger blocks of space for the big fish in the marketplace. These are calculated risks, but leasing professionals must make these types of decisions every day.

  Awareness of Existing Tenant Rights

  When strategizing about how to offer space to the market, it’s important to understand any existing tenant rights. Oftentimes, vacant space is encumbered, meaning there’s an existing obligation to another party with respect to the space. For instance, a current tenant may have a right of first offer, right of refusal, or an expansion right on an adjacent suite. As you market the vacant suite, you need to offer the vacant space within the parameters already set forth in the current tenant’s lease. Savvy landlords need to understand under what terms they can place vacant space on the market.

  I once negotiated a lease for an 80,000 square-foot space, which entailed moving five tenants—yes, five—none of whom had a formal relocation clause in their lease. How did I do it? I moved them to more desirable spaces or cut a better rent deal with them, and of course I paid moving expenses. After a bottle of aspirin and many late nights of negotiation, I was able to assemble the large block of space for a lucrative ten-year lease. That experience taught me the value of relocation clauses, especially in buildings with floor plates suited to large tenants.

  Term Length

  In the commercial sector, five-year lease terms are typical, with a preference (and occasionally rent discounts) for seven- or ten-year terms. In general, landlords prefer lengthy lease terms because of the assured stream of rental income.

  Also, typically, the higher the level of tenant improvements, the longer the lease term an owner will want, in order to allow for the amortization of capital investment, especially for customized space. On the other hand, a landlord might offer space with a shorter lease duration, especially when tenants take the space as is or with minimal investment, when a space has proved difficult to lease, or when a short-term tenant acts as a placeholder of sorts, paying rent on space that might ultimately be absorbed by other existing tenants.

  Alternatively, a landlord may choose to lease an entire property to a single tenant—wonderful for rental return but perhaps vulnerable for lease renewal as the lease expiration nears and the landlord faces the prospect of a completely or mostly vacant building. On the other hand, varying lease expiration terms create more balance but can also limit the landlord’s ability to assemble a large block of space in a single offering. In the end, though, decisions on term length are based less on landlord preference and more on the demand in the marketplace.

  In San Francisco’s hip South of Market area, innovative leasing is alive
and well. There, RocketSpace offers thousands of square feet of incubator space to over 130 seed-funded technology start-ups. The space provides flexible offices, technology support, and a community of tech innovators. The vibe is young and irreverent, as illustrated by the chalkboard directions that point Future World Leaders in one direction and Insecure Geniuses in another.

  Blend and Extend

  Oftentimes, existing tenants seek lower rents when the market has dropped considerably since the initial lease signature, or because of different circumstances in their own business. Landlords in such situations may want to “blend and extend” a new lower (mix of the old and new rates) rent in exchange for a longer lease term. While the landlord’s immediate rental income stream may decrease, the security of a longer lease term offsets the reduced rent. For example, assume an existing tenant has a five-year lease term. Several years into the lease, the market drops out and competing buildings entice your tenant with offers of lower rental rates. The tenant cringes at the existing high rental rate and resentment builds. While it might be perfectly reasonable for the landlord to argue that the lease’s rate was fair at the time of signing, a better strategy often is to reduce the tenant’s rental rate to that of (or closer to) the current market rate, and to blend the old and new rates over an extended lease term.

  The tenant wins because the rent is now consistent with the market. The landlord wins because the tenant’s term has been extended (possibly without incurring a brokerage commission and tenant improvements), thus creating value, and the rent is still at a competitive market rate. The landlord’s initial tenant improvements and other capital investments will still be amortized, albeit over a longer term, and the possibility of incurring new capital expenses in connection with replacement tenants will have been minimized.

  Rent

  Probably more than any other aspect of the lease, tenants, landlords, and brokers focus on rent. Setting the appropriate rate positions your property for success. Although it’s a bit academic (because net rent is actually a calculation determined by a variety of factors), the face rental rate is typically what is advertised and, oftentimes, first reported for a lease. So while you learn the complexities behind the face rental rate and learn that a lease’s value depends on a variety of economic factors, you need to acknowledge the high profile the market gives to this number.

  Leasing plans establish a pro forma rent, the rental income needed to service the building’s debt, pay its utilities, and operate the property with positive cash flow. Usually, pro formas are determined during the development or purchase period of a building and can evolve with changes in the loan structure and operating costs. But regardless of any pro forma, rental rates will necessarily reflect only what the competitive market will bear. It is therefore critical to understand comparables in the marketplace in order to set a rental rate that can compete with other buildings.

  The property lender can exert a significant influence on a building’s leasing efforts too. Nowadays, there’s a growing trend of lenders having approval rights over lease deals exceeding a certain size or term or varying more than an allowed percentage below pro forma. Of course, these requirements vary from lender to lender (and property to property).

  With an understanding of the various iterations of rent such as net rental rate, blended new and old rates (in a lease renewal), and the impact of capital improvements on rental rates, you can craft a stronger overall lease.

  Face Rent Versus Net Effective Rent

  Real estate leasing professionals differentiate between the (face) rental rate and the (net) effective rental rate. The face rent is the nominal rental amount listed on the lease. The net effective rent is the actual rent once any tenant inducements such as free rent (also called abated rent), reduced rent, and higher tenant improvement allowances are taken into account. Any landlord concession that reduces the tenant’s rent obligation affects the net effective rent.

  Because many office leases are gross leases, meaning they include operating expenses and, often, tenant inducements, it can take some arithmetic to uncover the net effective rental rate. For example, suppose you rent a suite for $36 per square foot per year for a three-year lease term, and you give your new tenant six months of free rent at the commencement of the term. While the face rent is $36 per square foot, the net effective rent is $30 per square foot per year, as you only collect rent for thirty months (rather than thirty-six) once the free rent is factored in.

  Keep in mind that the time value of money also needs to be considered, as for instance, six months of free rent today (assuming a constant rental rate) is costlier to the landlord than six months of free rent spread over the entire term of the lease. That’s because giving free rent initially denies the landlord use of those funds for investment, while spreading the rent concession over the term allows the landlord to use (invest) that money in the intervening time.

  Landlords tend to pay attention to face rents because these are often the rent comparables quoted in the marketplace. Also, when tenants renew leases, they often refer to the face value of the rent for renewal comparisons, neglecting (or forgetting) to calculate the true effective rent. Generally speaking, the higher a face rent, the better the deal appears for the landlord.

  Whether leases are gross leases, triple net leases (exclusive of operating expenses which the tenant pays), or economic triple net (in which the landlord still provides the services), the point is that you’ll need to unravel the various lease concessions to ascertain the true net effective rent of any lease.

  So setting rental rates becomes a nuanced process because all the economic factors of a deal, including tenant improvements, architectural fees, brokerage commissions, any periods of free rent, the lease term, and so on, conspire to affect the effective (net) rental rate. And, a good leasing agent can make a better net deal by streamlining tenant improvements or renewing a tenant sans brokerage commission, thus raising the net effective rental rate. To further complicate a building’s return, one tenant’s slightly lower rental rate can be offset by a more profitable rental rate of another tenant, making the building finances as a whole workable for the landlord. So while face rental rates have their purpose, wise leasing agents focus on net effective rates.

  I once turned market knowledge into gold during lease renewals. I had a suburban property outside the limits—and tax jurisdiction—of a city that imposed payroll taxes on businesses, thus creating lower effective rental rates for my property. So I created a chart comparing our effective rent to the city-rent-plus-taxes number. The exercise so effectively exposed hidden costs, that my tenants—especially those with large payrolls—often chose to stay instead of moving inside the city limits.

  Saving Face

  While leasing agents may quote the face rental rate as they exchange comparables, know that the effective rental rate is the true rate that matters in terms of value and return on investment.

  Rent Prices Can Connote Value

  Because each lease deal is different in terms of the capital required, many landlords advertise rent as a range, with the ultimate rate a function of tenant improvements and other financial components.

  Pricing involves a mix of market knowledge and psychology, much of it backed by studies. For instance, a Yale University study found that tiered pricing choices led to buyers making more decisions to purchase.9 That tiered pricing may represent suites throughout a building, from the penthouse to a subterranean space for call centers. While long-term leasing decisions certainly differ from selling packs of gum, for example, research also implies that psychology impacts purchase choices, leading sellers to price goods and services accordingly. As a practical example, buyers often make a correlation between price and quality. Thus, raising rent or keeping rent near the upper end of your competitive marketplace may connote value in the eyes of a prospective client.

  In a classic example of tenants equating quality with cost, I worked on a 15,000 s
quare foot lease for a technology firm that didn’t feel quite comfortable with our building architect. In an effort to win over the tenant, the architect offered to draw the conceptual space plans for free (with the belief the tenant would like the design and proceed with the complete plans). The plan, however, backfired. The tenant told me that if an architect was willing to work for free, he probably wasn’t much good. This taught me that undercharging or not charging for work can undermine the perception of one’s value. That’s why I decided to keep our rental rates on the upper side of the competitive market scale.

  Operating Expenses

  Landlords determine which operating expenses are included in the base rent and which are paid directly by the tenant. “Gross” or “full service” leases mean that the landlord provides and pays for the utilities and other expenses incumbent in running a building. Typically, landlords seek reimbursement for a pro rata share (according to the tenant’s square footage) of expenses or of increase in expenses. Other leases though, exclude operating expenses, in a “net” or “triple net” arrangement. Buildings usually follow market trend with regard to the structure of operating expenses relative to the lease.