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THE ART OF NEGOTIATION - PART III
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NEGOTIATING IN THE REAL WORLD
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In the previous newsletter in this series on the “Art of Negotiation”, we concentrated our attention on properly analyzing and negotiating an individual lease clause. In the real world of negotiation, it's important to realize that a little knowledge can be a dangerous thing. While both the tenant and landlord absolutely need to understand the possible consequences of any lease they sign, the parties must also recognize that market conditions will have an impact on what is achievable in their negotiation.
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I would preface this by saying that in any negotiation, the relative power of the parties is rarely equally balanced. In leasing commercial real estate, market forces will generally dictate who has the greater advantage in the negotiation, the landlord or the tenant. Therefore, when I refer to “market forces” or “market conditions” throughout this newsletter, keep the following explanation in mind:
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In a slow market, where there is more available space than tenants to fill that space, landlords will be in competition with one another and the tenant will generally have the advantage. On the other hand, when a tight market develops and space is limited, tenants will be in competition with each other for the available space and the landlord will have the advantage.
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Preparation - The Key To Success
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As a part of the preparation that must precede a negotiation, I always prepare a full analysis of the landlord’s standard form lease so that my client will be fully knowledgeable and able to pick-and-choose their "fights". While this entails a bit of effort on my part, a client MUST know what the issues are BEFORE they can begin to make business decisions on how to deal with the concerns that my lease analysis reveals. In essence, they must prioritize the issues that are most important or critical and decide which, if not all, are within their ability to negotiate a change.
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When a client chooses to retain an attorney to review the lease, as they should, there are always additional comments but these are generally limited to legal considerations. Even highly skilled real estate attorneys find value in the "broker’s analysis" which I prepare. I should mention that the knowledge necessary to prepare this analysis is contained in the 73-page Lease Clause Analysis section of our how-to course. The process I use to analyze a lease was detailed in a previous newsletter. If you would like to review this information, Click Here and a new browser window will open automatically. |
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While the "broker analysis" can sometimes save my client legal fees, this is not its intended purpose. Many attorneys will first prepare their own analysis and then compare. The benefit is that my client is fully informed as to the business considerations that surround that lease. This is critical! Lease documents are potentially full of "unintended consequences" that are just waiting to trap the unwary. Properly educating a client in this regard need not involve giving legal advice or drafting lease language. |
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In addition, the in-depth nature and content of the analysis enhances my credibility in the minds of both the client and their attorney and allows them to think of me as a consultant rather than a broker. In that role, I am in a much better position to make sure that the negotiation stays in a “deal making” mode, while continuing to represent my client’s best interests. |
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Avoid “Deal Breaking” Behavior
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It is important to recognize how easily “deal breaking” behavior can occur during a negotiation. Most often, it’s the result of focusing too narrowly on the issues and taking a hard line when market forces don’t support your position. I repeat. A little knowledge can be a dangerous thing! Those individuals with the responsibility for analyzing and negotiating the lease MUST guard against this behavior. |
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For example, our how-to course provides an in-depth and balanced presentation of the landlord and tenant negotiating positions for virtually every clause in the lease document. Even more importantly, it provides a layman’s explanation as to the “why’s” of each position that aid the principals in making business decisions during the course of a negotiation. While this knowledge is very valuable, its use MUST be tempered by the reality of what is realistically achievable in a given situation and a given market. |
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Essentially, “deal breaking” behavior arises when the individual negotiating changes to the lease does not have sufficient knowledge or authority to get beyond the lease clause analysis and make good business decisions. In the end, the landlord and tenant’s relative power in the negotiation, given the reality of market conditions, must be considered when deciding which battles are to be fought. The best business decision may be at odds with the pure legal analysis. |
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In a nutshell, lacking some compelling reason to the contrary, market conditions MUST support your negotiating position. The solution is to set goals and priorities, before the start of negotiation, that reflect the realities of the marketplace.
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Well, enough said but as they say, “an example is worth a thousand words”.
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Example
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I recently represented a valued client in a relatively small (6,000 rsf) transaction for office space in a building under construction. The market conditions could only be termed a “landlord’s market”. Newly constructed buildings are fully leased before shell construction is completed and the landlords can choose among a variety of tenants who desire to occupy their building (i.e. the supply is insufficient to meet the demand). As a result, Options to Renew and other clauses that benefit the tenant are more difficult to obtain. Tenants who take a hard line with respect to their lease comments, by submitting too many requests for changes, risk having their proposal thrown in the trash.
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Three additional factors would have a profound effect on this negotiation:
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The landlord was largely unsophisticated in commercial real estate (i.e. a residential builder constructing a small 25,000 rsf class "A" office building on a prime in-fill site); |
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The principals (landlord and tenant) were good friends; and
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The language of the landlord’s standard form lease was extremely onerous to the tenant. |
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In this case, the landlord had unknowingly obtained a lease document that was very onerous to the tenant and then embraced its use without much real thought or review, except he liked what he read, of course. As a result, my lease comments were an extraordinary 14 pages in length.
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It was evident that this was NOT going to be a simple lease negotiation if my client was to achieve anything that might resemble a balanced lease. For example, there were four or five "blank checks" given to the landlord. One of these "blank checks" gave the landlord the right, at the its sole discretion, to set up reserves for capital repairs and replacements, of which my client could be charged his pro-rata share.
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Compounding the difficulty would be the landlord’s ability to walk away from the negotiation and easily find a replacement tenant. After much discussion with my client, we decided that, rather than picking and choosing among the issues, the friendship between the two principals (landlord and tenant) would allow us to submit all of the lease comments for consideration. In the spirit of this friendship, we made sure that NONE of the requested changes would be onerous to the landlord. While the landlord’s broker fumed about the shear number of changes being requested and would have liked to just trash the proposal, it received fair consideration from the landlord himself.
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As a result, over 90% of the changes we requested were incorporated into the lease and both the landlord and tenant will be able to live within the constraints of the document without risking a negative future impact on their friendship. Had we not addressed the many points in question, the friendship might have tempered how the lease was actually administered. But… had the building ever been sold, etc., the lease could have become a bludgeon in the hands of an overly aggressive or unscrupulous landlord. |
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What? No friend building a new building?
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All right, so friendship prevailed in this case, but what would I do with this highly onerous lease when market forces were not in my client’s favor and there wasn’t a friendship on which to fall back on. Essentially, I would review and prioritize every concern and apply a thought process similar to the following to each:
- Would it be possible to alleviate the concern by virtue of the tenant insuring against the event? The additional expense would simply serve to increase the cost of occupancy.
- If the event, such as condemnation, were unlikely, could we consider accepting the onerous language? In the grand scheme of things, a satisfactory Option to Renew might be a far more important issue.
- If the default provisions are onerous, how diligent must we be in protecting our interests? For example, could we live with only a five-day grace period when we would normally request ten days? How critical an issue is it that the landlord could declare a default if we vacated or abandoned the space, even if we were not otherwise in default?
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In essence, as market forces put the tenant at more and more of a disadvantage, it becomes ever more important to concentrate on critical issues… and either problem-solve a solution for the others or choose to accept the possible consequences. In fact, should no advantage exist, such as friendship, size, financial strength, etc., the tenant might find it necessary to accept the landlord’s standard form lease, without any significant changes. Further, it might be impossible to even address critical issues, such as Options to Renew and the like.
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To illustrate this point, we recently represented a title company in just such a situation. The landlord, with multiple opportunities to lease the same space, would accept no changes to their lease and would grant no options. Since it was critical for the title company to have a presence in the building and not give their competitors an opportunity to encroach on their market, they choked down their concerns and made the business decision to lease the space.
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In a case like this, why would I still prepare a "brokers analysis" of the lease? If the tenant chooses to accept onerous language in the lease, they should only do so with a full knowledge and understanding of the potential consequences. I consider it my job to make sure they have that knowledge.
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For the sake of comparison, let’s assume that the situation was reversed and it was a strong tenant market (i.e. more buildings with space available than tenants to fill that space). Obviously, the tenant would submit his entire list of concerns. So long as the requested changes weren’t overly onerous to the landlord, the tenant would expect to receive concessions in this regard. |
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Again though, a great deal of thought should still go into prioritizing the importance of each request since its unlikely that a consensus can ever be reached on all of the issues. Also, keep in mind that landlords are, with justification, quite averse to making any changes that would affect the value or salability of their building. |
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Negotiate With Confidence!
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The key to complete confidence is this - you MUST be able to negotiate competently. Don't just rely on an unstructured approach and think that this is what will achieve the desired result. IT WON'T! You will fail to address a significant issue or you will fail to address a critical concern. The negotiation needs to remain focused and this can ONLY occur when you adequately prepare PRIOR to the start of negotiations!
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Repeatedly, people are convinced they can negotiate effectively by the seat of their pants… When I have the opportunity to review the results of these transactions, I can see that there was not enough attention paid to the various issues of significance that surrounded these lease negotiations. So just remember...
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While both the tenant and landlord absolutely need to understand the possible consequences of any lease they sign, the parties MUST prioritize their concerns and give full recognition to what IS and IS NOT achievable in their negotiation.
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Summary Thoughts
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I want to mention that during development of the how-to course, every effort was made to present a balanced view of the leasing process. Hopefully, we accomplished the same thing in this newsletter. It is our belief that win-win negotiations only occur between fully knowledgeable landlords and tenants.
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Well, the space available in this month's newsletter has pretty much been exhausted. While we have only been able to touch on a few of the key issues surrounding the negotiation of lease clauses, I hope the information has proven to be entertaining, enlightening and will prove useful in your day-to-day activities. As I mentioned earlier, our
how-to course
is where I reveal all of the "nitty gritty" on EXACTLY what you need to know in order to successfully lease commercial real estate.
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Steven M. Wennerstrom
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