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Office Leasing Comps. And Your Point is…?

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Dan Mihalovich

Dan Mihalovich

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True or false? Office leasing “comps”—the vague, incomplete and alleged details of completed transactions—tell one where the market is. False.

True or false? Comps are reliable information upon which to base one’s renewal of a lease. False again.

True or false? Comps provide an accurate basis for negotiating a lease with a start date of 9-12 months from now. False. See a pattern?

Comps are highly touted by commercial real estate firms. They’re part of the raison d’être to hire that firm, so says the firm with all the market “intelligence”. Granted, comps make interesting reading. If you’re a tenant, however, especially a tenant looking to hire an objective and aggressive broker to represent your interests (such as Mihalovich Partners), read on…

If managed properly, the renewal/relocation process should commence far in advance of the new lease term. The purpose of the long lead-time is not just to allow the luxury of time for tough negotiations with the landlord community, it’s to allow plenty of time for discussion about your business and prospects; team selection; creation of strategy, etc. Reaching out to your landlord, or others outside your building too far in advance can produce misleading information.

Without duress, many landlords will contrive the most hideous of lease comparables—those recently completed transactions—which in the landlord’s view make their case for where the market is headed.

We cannot describe in this space, without writing volume, how manipulative the “comps” data becomes.

Remember that lease transactions are NOT recorded, publicly. Lease transaction data is often shared between landlords, landlord-brokers and tenant-brokers. Nevertheless the data is founded on hearsay and is often reported incorrectly.

Does the landlord have an obligation to share its data and substantiate its claim of “fair” rent for tenants considering exercising a renewal option? Most frequently, not.

The standards of the lease, however, are founded on the spirit of good faith and fair dealing.

Is the door open for the parties to “cook” the “Fair Market Rent” clause? Absolutely. Isn’t there great risk to the tenant, to our clients, subjecting oneself to such a process? Absolutely.

Consider that concessions given to other tenants reflect deals negotiated by other brokers—not your broker; not for the quality/credit/longevity of your tenancy; and probably not for the timing of your tenancy.

We must underscore the likely pitfalls of subjecting one’s financial future to outside “comps” at all. Not only are there authorship issues, insofar as we are likely to negotiate better terms for our clients than other tenant-representation brokers, but the notion that a tenant MUST rely on deals already completed signals a locked-in loss for tenants in a falling market.

Why would a tenant voluntarily subject itself to setting a “fair” rent for a new deal 9-12 months hence (in a declining market) based on deals gone by?! Conversely, in a rising market, tenants should expect landlords to manipulate the comps to reflect only the most recent and most expensive comps.

Most renewal clauses are drafted in a manner which only obligates the landlord to propose “Fair Market Rent” in their reasonable discretion. In a rising market, if a single tenant in a single comparable building pays an egregious amount of rent, you can expect to hear from your landlord that that is the “fair” amount. Is the process contrived? Yes!

For those of you, tenants, who were attracted to your current space because once upon a time your landlord was under pressure to rid itself of an extended vacancy, and/or due to an unusual configuration of the space (perhaps inefficiency), beware that the landlord’s view of the same space will change markedly during the determination of “Fair Market Rent” in a renewal or in an arm’s length new negotiation. All the reasons the space sat idly on the market for months or years before you signed on are forgotten. The concessions the landlord made to you at the outset of your lease, because no one else seriously considered that space? All forgotten.

In the “devious” category: “Fair Market Rent” means fair market rent for whom? Is the issue, “What will the market bear for this space, given its as-is condition for the specified length of years, considering comparable space in comparable buildings?” In other words, is the issue, “What will any ready, willing and able tenant be willing to pay….?” Or is the issue, “What should THIS tenant pay for its specific use in this made-to-order space for THIS tenant?”

The notion of “market” and fair determination of value must be determined by considering what a reasonable field of tenants would be willing to pay for such space.

How does one determine the value of an albatross? If a space is so unusual that its salvage value upon re-leasing to the open market is ZERO (i.e. the space will necessarily have to be demolished and rebuilt in order to re-lease the space), then the utility of the space, or lack thereof, must be considered as “Fair Market Rent” is determined. But in the contrived world of renewal-option clauses, landlords may surprise and disappoint you with distorted interpretations of basic English. Generally speaking, if the space looks and smells like a pig (you leased the space because it was a “steal”), it will be slaughtered once you vacate to another location. On the renewal, however, expect the landlord to perfume that pig. It’s in their interest to do so and you should avoid locking yourself into a renewal. Again, buyer beware.

The games continue, ad nauseam. For those of you considering exercising a renewal option, beside stating, “Don’t do it!” consider this:

Tenant exercises the renewal option. Landlord floats their initial “reasonable” rental rate. Shock sets in. Why? Because the landlord refused to entertain any discussion about forecasted rent prior to the tenant exercising its option. After all, the tenant controls the renewal term, not the landlord.
The landlord offered to discuss renewal terms, but only after the expiration date for the tenant to exercise its renewal option. The landlord’s shocking salvo appears just at the time the parties are to enjoy one another’s company in a 30-day (or so) period of “negotiations”. If the parties can’t agree to terms, or simply don’t want to, this period will lapse without progress. Typically, what ensues is another debate—this time between representative-brokers or appraisers of Tenant and Landlord.
Surely they will resolve the mess, or else! Or else what? Or else both parties risk turning over complete control to a 3rd broker or appraiser, whose qualifications are known but oftentimes little more as to how that person will actually resolve the dispute between the parties. One must rely on the negotiated and imperfect language of the lease to spell out the role and process for the 3rd broker/appraiser.
Even if the process were perfect, tenants, how can this contrived process result in a conservative and controlled determination of your company’s financial future?

The reliance upon “comps”, whether for renewal or relocation purposes, can be misleading and does not constitute astute fiduciary duty to one’s shareholders.

Our clients enjoy their financial stature resulting from years of hard, smart work and planning. In an open market transaction, we can negotiate an outcome to a renewal or relocation transaction of far higher quality by blazing our own trail and focusing on what our clients can afford—not based on what others have paid.

Our clients have leverage and we know how to use it. Exercising renewal options simply leaves a lot of money—and time—on the table. And we hate leaving money on the table.

Think about it.


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About the Author

Dan Mihalovich

Mihalovich Partners, a San Francisco based commercial tenant-representation firm, was formed in 1998 by Dan Mihalovich, then a 16-year Industry veteran and Director of Office Leasing at Cushman & Wakefield. Mihalovich brings to the firm 35 years of business experience, focusing on Market Analysis, Negotiation Skills and Project Management expertise. He has managed over 200 office-leasing and project management assignments for many of San Francisco's most prestigious tenants. His career, and the focus of Mihalovich Partners, is solely driven to advocate the interests of San Francisco tenants in leasing negotiations of all types—renewals, relocations, renegotiations, and terminations. Mihalovich Partners never represents landlords, avoiding conflicts of interest, unlike most firms in the leasing brokerage business.

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