While we cannot entirely eliminate the impacts of inflation, there are things we can do to mitigate them.
Pass Throughs. When it comes to operating expense pass throughs, you are going to want to take a close look at the breakdown of the operation expenses to determining how effectively the landlord has been in cost control over the previous three years. A good landlord will regularly protest county assessor’s assignment of market values of the property to make a case for a lower valuation. You will also want to look at how effectively the landlord been in the past in purchasing the building insurance premium. Regarding Common Area Maintenance (CAM), you will want to evaluate the landlord’s skill and effectiveness in managing venders how care for the building.
TI Construction Costs. Be prepared for higher costs and longer schedules than pre-pandemic. You may want to get an independent opinion from a construction consulting to determine if the landlord’s contractor is giving you the best pricing. You also want to look at the contractor’s change order history. Some general contractors issue few change orders, others issue them for the slightest reason. Change orders tend to be expensive and are generally passed on to the tenant. You will want to negotiate the highest construction allowance, and, if possible get a guaranteed maximum price from the landlord or their contractor. Also, budget at least an additional 10% for surprises.
Annual Rent Escalations. In addition to negotiating the best base lease rate, you will want to protect yourself against excessive annual rent escalations. While 3% increases have become fairly standard, some landlords will be trying to push it up to 4 or 5%. Some will even attempt to peg your annual increase to the Consumer Price Index (CPI). Our recommendation is not to agree to a CPI peg, and to negotiate the lowest annual fixed escalator you can. In your renewal options try to avoid the rent at ‘Fair Market Value’, which can be very arbitrary, with the landlord usually having the upper hand in those negotiations. You are much better off with a flat percentage increase……in the 3-4% range. If lease rates come down, you can waive your renewal option in and negotiate a more attractive rate based on Fair Market Value.
Length of Lease Term. In negotiating a new lease, a renewal or expansion you will want to evaluate the cost and benefit of committing to a longer lease term. Companies often avoid leases longer that 3-5 years because it is hard to project out beyond them. While a lease of 7-10 years ties the tenant to the space for a longer term, it may also provide the opportunity to lock you lease rate in longer, avoid some of the impact of inflation over the lease term. You will want to evaluate the risks associate with loss of flexibility versus the savings you can achiever through the longer term. You still may be able to negotiate a termination option after 3-4 years, at a pre-negotiated cost, which allows you to have the flexibility and the lower rate.
Hiring a 100% Tenant Rep, who represents you, the occupier of the space not the landlord, will be there to help negotiate all of these lease terms to your maximum benefit.