Editor’s Note: Rich Harris is a senior director at Advantis Real Estate Services in Durham, a leasing, property management, corporate real estate services, tenant and landlord representation, investment sales, construction, and strategic consulting firm. This is the latest is a series of guest columns for WRAL Local Tech Wire from the membership of the Council for Entrepreneurial Development (www.cednc.org ).
DURHAM, N.C. – For companies today, facility costs are consistently among the top three annual expenses. Yet in the fast paced world of a startup company, the time required to choose the best office space option often poses a formidable challenge to a management team.
A well-run real estate process requires thorough identification of prospective locations and diligent negotiations with multiple parties. This article is designed to preview the process of securing commercial space and offer tips to you and your company on how to do it effectively.
In a typical real estate transaction there are numerous economic (and non-economic) terms to negotiate. Those most commonly focused on by tenants include rental rate or “rate per square foot”, the escalation of that rate, the term of the lease and what I will term miscellaneous concessions — more commonly termed “freebies” (rent abatement, furniture, etc.). Yet this list is far from comprehensive and there are numerous other considerations to be carefully negotiated, among them: a tenant’s improvement allowance, security deposit, operating expenses, renewal options, expansion options, termination options, properly defining the commencement date and numerous lease provisions. These considerations are often labeled “secondary”, but inevitably prove to be the most common pitfalls for early stage companies moving quickly.
The commercial process involves the following stages, which can vary in duration based on the requirement: 1) Defining the requirement; 2) Securing consultants and service providers/refine the requirement; 3) Identification of options; 4) Proposal/negotiations; 5) Construction due-diligence; 6) Finalizing the term sheet; 7) Lease negotiations; 8) Lease execution; 9) Construction/vendor coordination; 10) Move in/occupancy. It probably goes without saying that the more time a company allows for this process the better the results. In any case, a company should plan at least 4-6 months to run a competitive process with the understanding that anything faster is likely to result in decreased flexibility and a less informed decision.
Now for the six tips:
1. Engage Consultants:One of the most effective ways to “level the playing field” in a real estate transaction is to engage your own consultant to interface with the commercial leasing agents, REIT’s or institutional real estate developers that represent the buildings of interest. What many tenants fail to realize is that these consulting costs are budgeted and almost always paid for by the landlord. This is true for a tenant’s real estate consultant or tenant representative, who is typically paid at lease execution, but it is also typically true for a tenant’s architect. Beware that if you do not engage a representative, the landlord’s agent is compensated a fee that is typically two times the normal commission (effectively absorbing half of the fee of the tenant representative). Ask potential investors and other vendors for references on good service providers and make sure to interview any service provider carefully to find the best fit for your company and the requirement. Good consultants will assist in refining your requirements and should maintain an active role of advocacy throughout the various stages mentioned above.
2. Adjust Expectations: One of the most common pitfalls of early stage companies is the inability to adjust their expectations to the current state of the market. This is true in a depressed market, but is far more problematic in a high demand – low supply market. In the latter case, many companies search for the holy grail of real estate deals only to have their options narrow considerably during the process. The ability for managers to adjust their expectations (not necessarily their objectives) through numerous proposals and comparison based financial modeling is critical. At lease signing, a CEO or CFO should be aware of at least four comparable transactions and the associated economic terms that the company has seriously considered — thus making an informed decision that can be validated by proposals and financial models presented to their board of directors or investors.
3. Create Competition: Another common pitfall is a company’s unbridled pursuit of only one real estate option. A company should be striving to create competition throughout the process. This may involve evaluating a sublease that falls outside of the preferred geography or sacrificing some other preference to bring an aggressive prospect into the mix of prospective buildings. It’s no secret that negotiating with multiple parties yields better terms. Furthermore, limiting options can derail your company’s launch date if the first choice space is unexpectedly leased by another tenant. It is imperative to keep negotiations moving forward with backup alternatives even when it appears your first selection is secure. Make sure you have a fully executed lease document (and any necessary party’s consent in the case of a sublet) to ensure the option is truly secured.
4. Prepare To “Sell” Your Company: Many start-ups are not adequately prepared to market their company to the prospective landlord(s). Try not to construe a request for financials, investor information or an executive summary of the business plan (depending on the stage of your company) as an insult. The landlord is simply doing routine due diligence on your company as it looks to underwrites the lease transaction; the same way your company might conduct due diligence on a potential customer. If the landlord’s confidentiality is in question, have a non-disclosure agreement executed before you provide any of the requested details. Savvy entrepreneurs that react positively and punctually to these requests are sometimes offered lower deposits or letters of credit and almost always enjoy stronger relationships with their landlord.
5. Seek a Better Understanding of the Prevailing Trends in the Market: Obviously as the market ebbs and flows with the forces of supply and demand, macroeconomic or local market factors can strongly influence areas of importance in the negotiation between the tenant and the landlord. In today’s market for instance, with construction costs rising dramatically due to high demand for natural resources, it has become increasingly difficult for start-up companies (with minimal credit history) to achieve a “turnkey” build-out allowance from the landlord. Thus, completing the necessary due diligence on construction costs prior to finalizing a term sheet/lease is critical in today’s market. Alternatively, a management team may seek to identify only second generation options (avoiding shell build out options) or place less emphasis on whether the layout consists of offices or cubicles.
6. There Are Numerous Ways to Achieve Growth & Expansion: Many start-up companies are extremely concerned about future expansion and thus limit their options to short term leases or subleases that will enable them to reassess the growth plans in six or twelve month periods. Unfortunately, this can lead to options with significant concessions being overlooked as a result. Companies should carefully evaluate all options and look to structure detailed expansion options or termination options triggered by a lack of expansion availabilities with that landlord. Furthermore, tenants should give special attention to larger parks owned by the same landlord or pick a large local landlord with whom they can grow their business. These strategies have enabled many tenants to enjoy considerable market concessions, while not sacrificing the ability to rapidly expand their company.
In closing, I am compelled to reiterate that new companies allot enough time to run an effective real estate process. There are substantial short term options (Regus, executive Suites, etc.) in the marketplace offering an office or two during the all-important “ramp-up” stage. Take advantage of these options if they allow your company the necessary time to make an informed decision.