Hedge funds and boutique financial services firms primarily focus on four things when negotiating their office leases- base rent, free rent, lease duration and scope of the landlord’s work. However, many tenants fail to realize that flexibility can oftentimes be negotiated and built into a lease as well.
In my opinion, below are some of the most important options that are often overlooked by tenants. If you have any other questions regarding your negotiations, please feel free to reach out to us.
The typical lease duration for a hedge fund is between three and five years. Most small to mid-size companies cannot predict their future headcount projections, and accordingly sign short-term deals. However, what if a tenant wanted to capitalize on the current low office rents while mitigating their risk? Alas, we have the termination option.
A termination option gives a tenant the right to terminate their lease at a specific point, prior to their lease expiration date. This option requires a definitive notice to the landlord in advance of the termination. Generally, somewhere between six months and a year is required, in advance of the actual termination date. Additionally, a penalty is typically assessed to the tenant and includes all unamortized deal costs.
Security Deposit Reductions – AKA “Burn Down”: A landlord often requires a sizable security deposit from small to mid-sized companies. The average landlord requests somewhere between six and twelve months of base rent. Accordingly, this can have a major impact on a company’s cash flow. A “burn down”, or reduction of security deposit, can often be negotiated into a lease. The burn down will typically occur halfway through the lease term. If a tenant is not then in default and eligible for the reduction, a burn down can decrease their security deposit considerably.
Renewal Options: A renewal option is often negotiated to protect a tenant from having their space leased out from under them. This option protects a both tenant’s rights and future negotiating leverage. A renewal option may shield a tenant from the following scenarios:
- Another tenant might be willing to pay a higher rental rate.
- An existing tenant in the building might require the space for expansion.
- A tenant might have put a tremendous amount of capital into improving the space and it would be costly to replicate.
Landlords reluctantly grant renewal options because it limits their flexibility to market the space to prospective tenants. Renewals are typically offered at the greater of the tenant’s then escalated rent or Fair Market Value (FMV). Focusing on a predetermined rent for the renewal will most likely yield the most favorable results. Renewal options that allow a landlord to raise rents based on fair-market rates can result in large rent increases, especially if the space is in a booming neighborhood.
Expansion Options: A growing tenant might request expansion options when negotiating their lease. This right enables them to expand into additional or adjoining space, providing it is necessary for growth. Expansion options have several variations.
- Fixed Expansion Options: The tenant has a defined period of time to exercise the option on a defined space.
- Right of First Offer: If any space becomes available in the building the landlord is obligated to present it to the tenant before marketing it to third parties.
- First Right of Refusal: Obligates the landlord to present any deal that they are willing to sign with another party for the space. If there is interest from the existing tenant with the expansion option, the tenant may elect to match the deal and preempt the other negotiations.