Preparing for an Office Lease Expiration

The headquarters office space is the most central aspect to an organization and a major component of its identity. For groups that lease their headquarters space, a decision must be weighed every five or ten years on whether to renew or relocate. CEOs and CFOs and other decision-makers will ask about the steps necessary to begin the process. Here are the things to consider as you get started on your review.

Critical Dates

The most important matter when contemplating a review of an office lease is knowing any critical dates associated with it. Among many dates and clauses within a lease, the most important critical date is the lease expiration. This is the date the contract with your landlord ends. There are ramifications for missing this date and remaining in the space beyond the natural expiration. A holdover provision may cause the organization to automatically renew its lease for a short period of time at double rent, or worse, suffer from both direct and consequential damages incurred by the landlord because of the holding over.

Another critical date that an organization may have in its lease is an early termination provision. This provision is negotiated in many long-term leases and allows for a lease to be terminated at a specific date prior to the true lease expiration. Where a termination option exists, the tenant provides advanced written notice, usually a year in advance, and a payment to reimburse the landlord for unamortized costs of making the current lease. Sometimes this payment will include several months of rent in addition to the unamortized costs. All or a portion of these payments might need to be given to the landlord at the time of notice, with any balance due prior to the effective date of termination.

The option to renew provision is also an important critical date to understand. This is the last moment that a tenant controls its ability to remain in its space. It is crucial that in a real estate strategy which includes the alternative of remaining in the existing space, the decision is made ahead of the renewal option notice date. A renewal option provides the tenant leverage in a negotiation with the landlord. However, once the renewal option date passes, the landlord can negotiate with any other tenant to occupy your space. One might ask why a landlord would do this. There are several circumstances where this might occur. The size of the space plays a role in the landlord’s decision. Your organization might be a small tenant in the building and there are one or more larger tenants needing additional space. The need to accommodate a large growing tenant may take precedent over a smaller one, even one that has been in the building a long time. It may be as simple as they want to go a different direction or have another use for the space. The bottom line is that an option to renew favors the tenant and controls the timing and conditions of the renewal term.

Starting the Process

Most organizations should begin their evaluation from 12 to 36 months prior to a lease expiration or early termination date. The time necessary will be based on several factors including the size of the office, market conditions and the organization’s internal processes. Should the organization conclude that it will be relocating to new space, then it requires a decision at least one year ahead of any critical dates. This provides the organization the time necessary after a lease is executed to prepare and construct the new space. If a decision is made to stay, then it is best to have enough time to study the market prior to any renewal option notice periods in the lease.

Experience shows that it typically takes longer for nonprofits to make real estate decisions.

As an organization begins to consider its lease’s critical dates, it also must layer in how and when decisions are made internally and any input its board will have in a final decision. The timing of board meetings, annual meetings and other key events impact the schedule and possibly the signing of a new lease.

The boards of nonprofit will influence the real estate project and staff will need to navigate this oversight. The size and complexity of the project is one factor on how involved a board becomes. It is not uncommon for a board to create a real estate task force to work with staff on a lease review. In these situations, the task force might take a hands-on approach during the process and serve as a sounding board prior to approvals by the board. In other cases, the board’s executive committee monitors the staff’s actions and provides carte blanche, so long as certain financial and business parameters are met. Here senior staff has the ability to move the real estate process forward with little or no input. It is important to understand which type of board you have before the process begins.

No matter the role the board takes in reviewing these actions, senior staff should form its own internal working group. Many times, this group will just involve the two or three most senior staff members. Sometimes the CEO will delegate this task to the COO or CFO and only be involved in major decisions. In larger organizations, the internal group might compose senior staff and major department heads in order to receive input from major stakeholders.

Whatever your internal process, senior staff needs to understand the financial implications of renewing your lease or relocating to new space. The real estate decision will cause the organization to incur expenses beyond any landlord concessions provided. The cost to construct the space, pay architects/engineers and other consultants, relocate and acquire furniture and technology are significant today. Identifying potential cash required and knowing how and when it will be funded should be clear to all stakeholders at the beginning of this evaluation. Sharing with the board of directors early is always better than having a surprise at the eleventh hour as you are concluding the lease negotiation and seeking final approval.

Your External Team

Having your internal team set, it is then time to assemble an external team of professional advisors. The first advisor generally hired is a real estate broker that specializes in exclusively representing office space users—a tenant representative. Today’s real estate broker will bring market insights, negotiation skills, financial savvy and an ability to serve as your organization’s advocate. The broker engaged must be able to guide the organization through the pitfalls of the process and understand the quantitative and qualitative factors that impact decisions. A broker must understand the effect each lease issue has on both the tenant and the landlord.

The following should be considered when engaging a real estate broker:

• The individual should specialize solely in representing tenants and not represent any building owners/landlords.
• The broker should demonstrate knowledge and insights about the local office space market and have a track record representing nonprofits and other users of similar-sized space.
• The professional should demonstrate an understanding of how nonprofits operate, and the decision-making process used.
• The firm which the broker works for has resources to support the efforts. Resources that might be relied on during the project include financial analysis, project management, move management and market research.

One of the broker’s critical roles is to serve as the coordinator of the project team. On medium and large square footage projects, engaging a project manager from your broker’s firm is an important addition to the broker’s team. While the broker will negotiate on the organization’s behalf, the project manager supports these efforts and oversees the new space getting built. The project manager, or owner’s rep, plays a key role in managing budgets and the schedule and will engage other consultants and vendors on the organization behalf at the appropriate time.

Working with the organization’s internal team, the broker and project manager, after understanding the tenant’s needs and requirements, will identify and select an architectural firm and other consultants that are necessary in completing the project. The architect/space planner is usually the next member of the project team added and should be hired early in the process. Typically, an RFP and interview process will be conducted to choose the firm that fits best. The architect/space planner will play a greater role in large and medium sized offices; evaluating an organization’s current and future space needs, describing workplace trends, how furniture and systems are used and recommending the type of space and floor plates that work best.

Let’s Go

At this point your organization is ready to start down the path to define needs, evaluate the market, short-list options and make the real estate decision. Once a building is chosen a general contractor will be selected to assist in budgeting construction costs associated with the tenant build out and ultimately constructing the space. There are many points during the real estate process where legal advice will be required. In addition to reviewing the lease document, your attorney will be reviewing any contracts with consultants and other vendors.

A decision maker must go into the real estate process with eyes wide open. There are always surprises when evaluating a dynamic office space market. Competition for quality spaces is always high and this sometimes forces a decision quicker than the organization is able. Understand that curves balls will be thrown and be prepared for them when they appear.