The Devil is In the Details
Traditional companies, such as law or accounting firms/insurance or financial brokers, negotiate leases that reflect the economy at that particular time. The economy has been the traditional driver of commercial real estate. An important component of the economy is the unemployment rate as this discussion in Bankers Toolbox illustrates.
If the economy is good that means that companies are hiring, growing and have a positive outlook towards their short term future. These traditional companies will take longer leases so they have stability and take more space so they have room for expansion. They may upgrade to a better building with a better location or better amenities. As they are doing that, they are taking space off the market which tightens supply. As the supply of office space tightens, and few new buildings are coming on the market – prices will rise. So when the question is asked – “how’s the market?”, that question has to be clarified by how’s the market for whom? A good market generally means there is a lot of activity, caused by the good economy, which is good for landlords. A bad market generally means there is little activity, caused by a poor economy, which is good for tenants. The good market drives prices up and the poor market drives prices down. These are the laws of supply and demand.
The tech companies, on the other hand, are all about creating new products and bringing them to the market. If the product is successful and takes off, the tech company will hire to meet the demand and expand its R&D to develop more products. This change in the status of the company can happen very quickly. And when it does, they will need more space immediately. Thus the tech companies need for space is not economy driven but is product driven. Of course a good economy can help product sell; but a good product can also be an economic driver.
This can happen at any time to the tech company. Therefore the proper negotiation of the business terms becomes paramount. Flexibility and expansion capabilities are of key importance. This includes an option to cancel the lease, options to expand into adjacent space and even includes a right of first refusal on other space in the building. The sublease and assignment clause must be carefully negotiated so they can be utilized by the tech company to easily leave the space. A larger landlord with a large portfolio of buildings may be desirable because they will want to keep the growing tech company in their portfolio. They can release the growing tech company from its lease allowing them to move into a different building within their portfolio.
All of these options are to accommodate the tech company’s rapid growth and hiring. Of course the rents and other costs must be contained so as to not saddle the tech company with a financial burden which will detract from their true mission of developing products. Most landlord’s strategy is to reap the highest rent toward the end of the lease due to increases and pass-through’s. That gives the tech company an opportunity to negotiate much lower rental costs in the earlier years of the lease enabling the tech company to put its money into product development. The best technique to drive these deals to the tech company’s advantage is to negotiate on multiple buildings simultaneously. This will force the landlords to compete for the tenant. This is best done by a broker who specializes in tenant representation because they never represent landlords and have no conflicts of interest.