September 24, 2009

Real Estate Alert: Five Tips For Getting Leases Done In A Down Market

Arnold & Porter Advisory

By Kenneth A. Neale

Until somewhere around the middle of 2008, the office lease market in most metropolitan areas in California was fairly healthy, with single to low double-digit vacancy rates and solid rents. Since that time the market has turned decidedly negative — rental rates are plummeting, vacancies rising, and there are fewer and fewer tenants in the marketplace. This situation is not expected to improve in the foreseeable future. Aside from the obvious economic adjustments that a commercial office landlord will be forced to address in marketing space under these difficult economic conditions, a landlord would be smart to reassess its approach to negotiating leases with the goal of expediting the time it takes to get the deal done.

In this market, once a landlord has a tenant interested in a space, it is essential to get the lease signed as soon as possible. The landlord cannot risk a long drawn out negotiation process. The last thing a landlord wants is for the tenant to leave for a better deal elsewhere — and, in this market, better deals are coming frequently. For your average office lease deal, anything longer than two weeks from a signed letter of intent to a signed lease is too long.

Below is a list of suggestions for speeding up a lease deal:

  1. Lease Form. Landlords need to take a hard look at their lease forms and consider whether they are hindering deals. Over the last ten years or so, office lease forms have gotten longer and more one-sided. Long leases mean more time between drafts and longer and more difficult negotiations. In my view, the added length confers only marginal benefit to the landlord. Except in rare circumstances, there is no reason to have a lease form longer than 30 pages on ordinary 8-1/2x11 paper, with a standard type size.

  2. Clinging to Rigid Stances. Too often a landlord will take the position that it will not change a lease provision out of "principle." Many times I've heard the response "we never make those kinds of changes" or "that's just not something we do." The game has changed and it's time to re-examine those principles. No lease should be held up because a landlord refuses to provide a notice period for monetary defaults, wants holdover rent to be 200%, won't share bonus rent on at least a 50/50 basis in the event of an assignment or sublease, wants unreasonable recapture rights, wants a 10% late fee, or has an unreasonably broad definition of operating expenses that could saddle the tenant with large capital expenditures and environmental remediation costs. A rigid, dogmatic approach to negotiating leases, even with smaller tenants, will not work in the current environment.

  3. "Pre-Negotiated" Lease Form. Recently, I have had an office landlord provide me with a "pre-negotiated" lease — that is, a lease that contains various changes from the landlord's standard form that the landlord will typically accept. This approach can greatly accelerate the lease negotiation period and is something that a landlord should consider. 

  4. Attorney Response. If a landlord is using an attorney (whether an in house or outside attorney) to prepare and negotiate its leases, it should demand rapid response both in preparing the initial lease form and in turning around drafts.

  5. Face-to-Face Meetings. Over the years, face-to-face meetings to negotiate leases have become scarce. Even phone calls are becoming less common with increased reliance on email. While email can be an efficient way to convey comments, it is a poor substitute for an in-person meeting. In my view, having a face-to-face meeting after a landlord receives a tenant's initial comments is an excellent way to hash out and resolve the major sticking points of a deal at an early stage.

If you have questions about any of the issues raised in this article, contact Kenneth A. Neale at 415.677 6322 or your usual Howard Rice attorney.

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