By Shantanu Mohan
July 1, 2018
The global financial crisis and recession haven’t exactly been a boon for small businesses. But one area where the turmoil has created opportunities for entrepreneurs is in renting real estate space.
“Overall, this has become a tenant’s market,” says Stuart Siegel, executive managing director for real estate broker Grubb & Ellis in New York City. “There are probably more small businesses that are nimble and able to act quickly during this crisis. They can capture landlords who are vulnerable and get anxious to make a really terrific deal.”
While the standard adage for businesses that want to rent space is that bigger is better, “We are seeing a lot more activity with smaller tenants now than larger ones,” Siegel says. “A lot of big companies are downsizing, cutting costs and putting space on the market for sublease.”
As a result: “Rental prices are coming down across the board from top triple A office buildings in New York City to strip malls and freestanding office buildings in smaller markets,” he says. “Tenants can often make numerous offers to see which landlord is the most vulnerable. It’s similar to the residential market, where vulture buyers are seeing who bites.”
Sherry Cushman, a senior vice president for CB Richard Ellis in Washington, D.C., who helps law firms finds space all around the country, has a client that wants to open an office in New York City with 10,000 square feet of space.
“When they started looking eight months ago, they couldn’t touch anything for below $70 per square foot, and most of what they were looking at was $90 to $100 per square foot,” she says. “Now the range is $50 to $70.”
The national office vacancy rate jumped to 14.8 percent at the end of last year from 13 percent 12 months earlier, according to Grubb & Ellis researchers. And they see things getting worse.
“Expect leasing market fundamentals to deteriorate more sharply in 2009 in response to very difficult economic conditions,” they wrote in a recent report. That, of course, is good news for small businesses looking for space.
“The opportunities are there for small businesses,” Siegel says. “Landlords that hadn’t contemplated pursuing smaller tenants are now looking to diversify and are willing to take small tenants in previously large spaces that are now divided into smaller ones. The number of small spaces tenants can consider in their searches has increased.”
Whether you are looking for a one-year lease or a 10-year lease, you have a good chance of getting your wish. “In good times, landlords could say, ‘We’re only doing five-year leases.’ The strong demand could get them that, and they wouldn’t have to negotiate,” says Jake Harrington, director of business development for On-Site.com, which helps landlords screen tenants.
Now things are different. “My associates are working with small and big businesses,” says Rob Cochran, managing principal of Colliers Pinkard’s Charlotte, N.C., office. “Maybe they have two to three years left on their lease. They can renegotiate for a longer-term commitment. Now is a good time for that.” If you’re a startup, you’ll want to negotiate as short a lease as possible, since you don’t know how long you’re going to be around. On the other hand, if your business is thriving, you should consider locking in today’s cheap rent for a long-term lease.
“Don’t take the price of the lease at face value,” says Rich Sloan, co-founder of StartUpNation, a Web site that assists small businesses. “Landlords are hungry to earn revenue from properties — hungrier than conceivably they’ve ever been because of the difficult economy. Try to lock in lower-than-advertised rent.”
What landlords like to do is offer tenant improvement dollars, subsidizing renovations for a space, or a period of free rent. “That way word doesn’t have to get out that rent is going down,” even though effectively it is, Siegel points out. You also may be able to negotiate a limit to future rent increases.
With all the monetary stimulus the economy is receiving, inflation likely will accelerate in coming years. Often lease rates rise in synch with the consumer price index. “Tenants should put a cap on that, saying annual increases aren’t to exceed 2 (percent) to 3 percent,” Harrington says. “You don’t want to get stuck with an 8 percent increase.” You often can negotiate an option to expand your space if you need more down the road. And you may be able to get the landlord to pay for management fees, janitorial expenses, maintenance and repairs. Sloan suggests negotiating for perks like parking spots, garbage removal and snow-clearing services if you’re in the north.
“This is more of a problem because landlords are concerned about the risk” of tenants failing, given the recession, Cochran says. “People are really looking at credit risk. If you’re already in a space, it’s probably not an issue.” But if you’re taking new space, be prepared to pay about 10 percent of your lease total as a deposit. “Landlords will typically require a letter of credit, and small businesses may be required to make a personal guarantee” to pay the deposit, CBRE’s Cushman says.
Small business tenants often aren’t aware of how important the security deposit is to a landlord, Siegel says. “Landlords don’t want to pay tenant improvement dollars and make other concessions and then get the space handed back to them six months later,” he points out. One exception to this rule: subleases. Companies that have too much space and thus must rent some out to other firms often aren’t in a position to ask for more than one or two months’ rent as a security deposit.
“It’s important for the tenant to be educated,” Siegel says. “Now is the time to see a lot of space.” He recommends working with a broker. “Very often small business owners feel they can find space and negotiate a lease on their own,” he says. “But I’m not sure they understand things like how a personal guarantee differs from a good guy guarantee.
“There are many nuances, such as escalator clauses, renewals, expansions and possible termination rights, where terms can be favorable to you in this economy if you know how to ask. Without a broker, you run the risk of the landlord taking advantage of you. A good broker and a good attorney will protect a tenant.” You don’t have to spring for a lawyer until you’re ready to sign a lease, Siegel says. But he emphasizes the importance of using a real estate attorney. “Attorneys who handle regular corporate legal work might not be the right counsel for a complicated commercial lease,” he points out.
That’s especially important in this economy, where many major real estate holders are taking it on the chin. “The creditworthiness of a building owner is very important,” Cushman says. “Are they restructuring a loan they can’t repay? Are they in some kind of trouble? It used to be that you’d just look at the tenant. Now you have to look at both sides of the table. In the larger deals, we almost always run a credit check on the owner.”
This is a great time to be looking for space. “I don’t think you’ll see opportunities this significant for a long time to come,” Siegel says. “It’s hard to time the market precisely, similar to the stock market. But a time when the market is in transition and landlords are nervous is a good time to act. A lot of people don’t know what the values really are for their spaces. So it’s a neat time for tenants to strike very attractive deals.”