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Cliff Hockley, CPM
President, Bluestone & Hockley Real Estate Services
Often real estate brokers are faced with deals that do not come together. Owners of real estate properties are not too happy when that happens. With this article I thought I would discuss some of the reasons commercial lease transactions might not close, and suggest possible strategies to help increase the closing percentage.
Typically an owner picks a real estate broker because of their credentials, or because they like each other and communicate well with one another. This is a good start, but sometimes more is needed to enable a deal to close.
The Screening
A broker needs to initially screen a potential tenant:
- Why are they moving?
- How much space do they need?
- What is their budget?
- What is the use, office, retail, flex, other?
- What are their growth plans?
- Is parking an issue?
- What location will work best for them?
- How is their credit?
- Who is the key decision maker?
- How are decisions going to be made?
- How long does it take to make a decision?
- Will signatures be personal or corporate?
- Is traffic count an issue?
- Dock high or grade doors?
- Ceiling height?
Once the screening has been completed, the broker needs to decide how best to approach the leasing project. Is a larger corporation looking for sites, or is it a Mom & Pop business? Is the space for a not-for-profit or a government agency? Each of these assignments should be approached differently.
Large Corporations (100+ employees, often with more than 1 location) - There are many stages to decision-making here. Usually one person does a search and then presents their recommendations to a regional decision-maker who then submits to a higher-up for approval and signature.
Small Businesses (under 100 employees) - The president or his executive assistant review search materials presented by a real estate broker. They then review with their comptroller and their bankers to make a final decision.
Not-for-profits – Typically the Executive director assembles a short list of properties that are submitted to a real estate search committee (or to the full board of directors) to make a decision. The board must make a resolution to allow the Executive director the right to sign lease documents.
Government agencies – Usually an agency prepares a Request for Proposal (RFP). Submissions are evaluated by the purchasing department of the agency or by a special unit that focuses on real estate negotiations for government agencies. These units typically work on the technical part of the negotiations while the agency head/management team makes the final decision depending on their annual budgets.
The Negotiation Cycle
In each of the aforementioned cases the negotiation cycle begins with a search of the market place, then typically proceeds to a “sticker shock” phase, followed by a phase where money is raised to close the deal. The time frame from search to close can take anywhere from 1 month to 3 years.
If an agency or a company is in the market more frequently, then the time frame is often shorter. If a company is making significant profits, the time frame can also be shorter. For larger transactions, you should include the time needed for a space planner or architect to plan out the space in a way that meets with the approval of the individual making final decisions.
Emotions
The emotions of the parties play a big roll in decision-making. Sometimes the property does not “feel” right to a major decision-maker: the windows are too small, it feels dirty, the location does not offer enough visibility. These emotional issues need to be taken into consideration as landlords and their brokers market property.
The Budget
Once a broker has presented potential leasing sites to a tenant, the tenant often realizes s/he did not budget for:
- moving
- tenant improvements
- the new phone system they need
- moving their phone lines
- the new copy machine they need to lease
- the grousing from their employees
- the number of parking spaces that will need
- new signage
- new furniture and computers needed for empty office spaces (or racking for warehouses)
- all the letterhead and printing stock that needs to be changed
- back-up generator for the computer system
At this point tenants usually contact their bank to establish if they have enough cash on hand or if their bank will extend them a credit line. Funding takes time to put in place, and because of the time involved, it tends to frustrate landlords as the vacant space is costing them real cash out of their pocket. Moving always costs more than you might expect.
From a Landlord’s point of view, the tenant must have great credit and cash in the bank before they will be leased to -- especially if the Landlord is investing major dollars in tenant improvements.
Timing
Well-organized tenants will look at least 12 – 3 months ahead of their need to lease space. They will have completed their internal cash needs assessment and space planning before they hit the market looking for the next space they need to lease.
Condition of the Property
A key ingredient to the speed of the closing is condition of the property that is to be leased. If tenant improvements are going to be elaborate, it will take longer to close the deal as drawings from architects and bids from contractors are needed before the landlord will sign. Savvy landlords focus on keeping their property ready to rent and try to avoid major tenant improvement expenses.
How long is that lease?
Most tenants don’t want to move every year so they will typically negotiate a 3–5 year lease. Longer term leases tend to get complicated for tenants and landlords as the crystal ball gets a little cloudy six years into the future. It is not unusual for a tenant to negotiate a longer term lease for a retail space if the location is very special. Single tenant buildings tend to have longer terms of 10-30 years.
Deal killers
- The lease form - If a lease form is too complicated or the terms are too onerous, it may force a tenant to walk away from the table to find a landlord that is easier to work with. Building Owner and Manager Association (BOMA) leases are well thought out for office and retail buildings.
- Tenant improvement costs – These build-out costs can become overwhelming for the landlord or the tenant. If the costs are too high, the tenant and/or the landlord tends to edge away from the table. For both parties the costs need to be carefully evaluated.
- Zoning/ change of use – If the property is not properly zoned, or the zoning will need a conditional use permit, the possibility exists that the change of use will kick in new building code issues/costs. These changes can kill the deal as construction costs escalate to make the building more earthquake proof or more handicapped accessible.
- Boards of Directors- it is important for the board to be very involved in the process. Good planning and communication will make deals work. Planning ahead and meeting with the decision-makers can facilitate a deal. Lack of planning and communication will kill the deal.
- Attorneys - Nicknamed “deal killers,” these are the folks that can make or break the deal by 1.) Not taking time to review the deal carefully and missing key issues in protection of the tenant. 2.)Taking too much time and finding so many issues that the landlord just pulls the plug on the deal rather than deal with the tenant’s attorney.
Tenants need to hire an experienced real estate attorney with a “deal maker” mentality. Working with the attorney early in the game and meeting them face to face to discuss the deal before the attorney’s lease analysis letter is written can be helpful. Some attorneys resent this, others welcome it. The attorney plays a major part in the process. Make sure you are well armed to explain market conditions to tenant attorneys.
Most landlords and tenants never realize how complicated putting a lease together can be. It takes broker experience, thoughtfulness and tenacity to make a lease deal stick. It also takes a willingness by the landlord and the tenant to make the deal close. The longer it takes, the greater the “cold feet” of each party. Taking the time to prepare will help all lease deals close more smoothly.
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