In the Spotlight: Renewing a Lease

For tenants, an assessment of the functionality of the space is critical. With technology changing so rapidly, the space and the building may not be “state-of-the-art” in meeting a tenant's technology needs. In addition, tenants need to assess if other operational aspects of the building and the space ' HVAC, elevators, parking and security ' have met expectations.

Landlords need to start early as well. As the lease expiration date nears, a landlord should meet, and be in regular communication with, those tenants.

Know Your Existing Tenancy

For a landlord, an assessment should be made of the quality of the existing tenancy. For instance, does the tenant pay its rent on time? Has it conducted contentious expense audits? Has the tenant abided by the building rules, particularly pertaining to alterations? Is the current tenant the same one that signed the lease? Often, during a long-term lease, the tenant has gone through a merger or buyout. What may have started as a headquarters lease with a Chairman and CEO in the space may now be back office space and/or sublet space.

Landlords should also gather information to assess the identity and creditworthiness of the current tenant and any guarantors. As discussed below, landlords should consult the lease documents and counsel to piece together any changes in the tenant entity during the term. Gaps in information can be filled in by the tenant, and many leases have provisions requiring the tenant to deliver current financial statements of the tenant and any guarantors upon landlord's request.

Know Your Landlord

For a tenant, information about the how the building is owned is critical. Is the landlord owned and/or controlled by foreign or domestic investors? Is the building owned in fee simple or subject to a ground lease? Is the landlord a single purpose entity, which is likely, and what are the debt levels and identity of the lenders? The recession has made everyone more aware of the potential for mortgage defaults and foreclosures. For instance, if the current mortgage will mature shortly, the tenant and its representatives need to understand how the owner intends to address such imminent loan maturity. Refinancing in today's markets is tight, and loan pay-downs often are required.

A tenant needs to inquire as to the existence of any so-called “mezzanine or mezz” debt. Such mezz debt, unlike mortgage debt, imposes a lien on the ownership interests of the landlord and does not involve a mortgage; thus it cannot be discovered with a search of the land records. If such mezz debt is in default and foreclosed, the ownership of the building transfers to the mezz lender.

Transparency

For a landlord, the strategy should be to demonstrate stable, well- funded ownership that is able to fund operations, capital improvements and tenant improvements, without the specter of mortgage defaults, foreclosure actions and lockbox notices. A stable landlord may be able to gain an advantage in the marketplace by being transparent and instilling confidence in any existing or potential tenant being considered.

For a significant size renewal, in particular, the steps that a landlord may take include: 1) disclosing to the tenant the source of funds for build-outs or renovations, brokerage commissions and the like; 2) disclosing to the tenant any building upgrades ' both cosmetic and building systems (provided the landlord is prepared to discuss how those costs might affect expense pass-throughs); and 3) advising its lenders when terms are agreed to on a lease renewal and getting assurances that the tenant will be provided a non-disturbance, subordination and attornment agreement.

Know Your Lease

It is unbelievable how many times landlords and tenants discover they are working with misinformation about their existing lease. Often, the persons deciding what to do as the lease expiration date approaches are not the individuals who negotiated the original lease many years ago. It is critical, therefore, for both parties to conduct a thorough review of the existing lease and all amendments early on. I recommend that an experienced leasing attorney conduct the review and even prepare a lease summary.

The parties may discover renewal rights, termination options and other terms of which they were not aware. One of the most common issues uncovered in a lease review is the absence of a definitive expiration date. Often, a lease commencement date is tied to completion of certain work or delivery of vacant possession. The parties may not have entered into a “Commencement Date Agreement,” which specifies exact commencement and expiration dates.

Sharing the Savings

As negotiations begin, an existing tenant and its representatives typically point out to the current landlord the enormous savings it will enjoy if it renews the lease ' and try to negotiate for a reduced or below-market rental in return. The tenant will aver that a landlord will not lose rent while marketing space that an existing tenant vacates, often referred to as “downtime.” If the landlord does not renew an existing tenant, it may have to incur costs associated with demolishing existing improvements, constructing new improvements, providing a cash allowance to a new tenant for improvements and giving free rent concessions. The existing tenant will hammer away at the supposition that by extending the lease for existing space, a landlord can mitigate the extent of these costs.

Experienced landlords know how to counter such arguments from their tenants and their brokers. Landlords also know that a lease renewal has “value” to their tenants. A lease renewal avoids the business interruption of a move. It saves time that the tenants' senior management would otherwise have to spend planning a move, designing a space, etc. It does not require updating customers, vendors and the world of your new location.

Conclusion

In the end, for a landlord, any deal with an existing tenant will take into account the market and options available to the parties, the vacancy rate and lease expirations of its building, the landlord's investment goals and debt picture. A lease renewal offers advantages to both parties and the focus of the negotiations should seek ways to “share the savings” that result.

Anthony Casareale, a member of this newsletter's Board of Editors, is a Partner in the Real Estate Group of Di Santo Bowles Bruno & Lutzer LLP.

The market has seen significant activity in lease renewals. This article examines the steps to be taken and the key issues to keep in mind if you represent either a landlord or tenant looking at a lease renewal as an option.

Early Assessment

For both parties, the first key is to start early. While there are no rules for determining how early to start, certainly, the larger the space required by the tenant, the earlier the tenant should commence an assessment of its options. A critical part of that early assessment is the interview and selection of its real estate broker.

For tenants, an assessment of the functionality of the space is critical. With technology changing so rapidly, the space and the building may not be “state-of-the-art” in meeting a tenant's technology needs. In addition, tenants need to assess if other operational aspects of the building and the space ' HVAC, elevators, parking and security ' have met expectations.

Landlords need to start early as well. As the lease expiration date nears, a landlord should meet, and be in regular communication with, those tenants.

Know Your Existing Tenancy

For a landlord, an assessment should be made of the quality of the existing tenancy. For instance, does the tenant pay its rent on time? Has it conducted contentious expense audits? Has the tenant abided by the building rules, particularly pertaining to alterations? Is the current tenant the same one that signed the lease? Often, during a long-term lease, the tenant has gone through a merger or buyout. What may have started as a headquarters lease with a Chairman and CEO in the space may now be back office space and/or sublet space.

Landlords should also gather information to assess the identity and creditworthiness of the current tenant and any guarantors. As discussed below, landlords should consult the lease documents and counsel to piece together any changes in the tenant entity during the term. Gaps in information can be filled in by the tenant, and many leases have provisions requiring the tenant to deliver current financial statements of the tenant and any guarantors upon landlord's request.

Know Your Landlord

For a tenant, information about the how the building is owned is critical. Is the landlord owned and/or controlled by foreign or domestic investors? Is the building owned in fee simple or subject to a ground lease? Is the landlord a single purpose entity, which is likely, and what are the debt levels and identity of the lenders? The recession has made everyone more aware of the potential for mortgage defaults and foreclosures. For instance, if the current mortgage will mature shortly, the tenant and its representatives need to understand how the owner intends to address such imminent loan maturity. Refinancing in today's markets is tight, and loan pay-downs often are required.

A tenant needs to inquire as to the existence of any so-called “mezzanine or mezz” debt. Such mezz debt, unlike mortgage debt, imposes a lien on the ownership interests of the landlord and does not involve a mortgage; thus it cannot be discovered with a search of the land records. If such mezz debt is in default and foreclosed, the ownership of the building transfers to the mezz lender.

Transparency

For a landlord, the strategy should be to demonstrate stable, well- funded ownership that is able to fund operations, capital improvements and tenant improvements, without the specter of mortgage defaults, foreclosure actions and lockbox notices. A stable landlord may be able to gain an advantage in the marketplace by being transparent and instilling confidence in any existing or potential tenant being considered.

For a significant size renewal, in particular, the steps that a landlord may take include: 1) disclosing to the tenant the source of funds for build-outs or renovations, brokerage commissions and the like; 2) disclosing to the tenant any building upgrades ' both cosmetic and building systems (provided the landlord is prepared to discuss how those costs might affect expense pass-throughs); and 3) advising its lenders when terms are agreed to on a lease renewal and getting assurances that the tenant will be provided a non-disturbance, subordination and attornment agreement.

Know Your Lease

It is unbelievable how many times landlords and tenants discover they are working with misinformation about their existing lease. Often, the persons deciding what to do as the lease expiration date approaches are not the individuals who negotiated the original lease many years ago. It is critical, therefore, for both parties to conduct a thorough review of the existing lease and all amendments early on. I recommend that an experienced leasing attorney conduct the review and even prepare a lease summary.

The parties may discover renewal rights, termination options and other terms of which they were not aware. One of the most common issues uncovered in a lease review is the absence of a definitive expiration date. Often, a lease commencement date is tied to completion of certain work or delivery of vacant possession. The parties may not have entered into a “Commencement Date Agreement,” which specifies exact commencement and expiration dates.

Sharing the Savings

As negotiations begin, an existing tenant and its representatives typically point out to the current landlord the enormous savings it will enjoy if it renews the lease ' and try to negotiate for a reduced or below-market rental in return. The tenant will aver that a landlord will not lose rent while marketing space that an existing tenant vacates, often referred to as “downtime.” If the landlord does not renew an existing tenant, it may have to incur costs associated with demolishing existing improvements, constructing new improvements, providing a cash allowance to a new tenant for improvements and giving free rent concessions. The existing tenant will hammer away at the supposition that by extending the lease for existing space, a landlord can mitigate the extent of these costs.

Experienced landlords know how to counter such arguments from their tenants and their brokers. Landlords also know that a lease renewal has “value” to their tenants. A lease renewal avoids the business interruption of a move. It saves time that the tenants' senior management would otherwise have to spend planning a move, designing a space, etc. It does not require updating customers, vendors and the world of your new location.

Conclusion

In the end, for a landlord, any deal with an existing tenant will take into account the market and options available to the parties, the vacancy rate and lease expirations of its building, the landlord's investment goals and debt picture. A lease renewal offers advantages to both parties and the focus of the negotiations should seek ways to “share the savings” that result.

Anthony Casareale, a member of this newsletter's Board of Editors, is a Partner in the Real Estate Group of Di Santo Bowles Bruno & Lutzer LLP.