SUCH A DEAL

“And I have great plans for this building.  It has great potential, and it’s a shame, that’s all, that the previous owners failed to keep this place up.  I’m seeing all new landscaping out front, a signature lobby, textured wall coverings in all suites, and restrooms with Italian tile and granite countertops.  It’s what I think you all deserve.  I’ll do right be you;  ask any of the tenants in my nearly 1,000,000 square feet of commercial rental property.”

The speaker was the new owner of a three story multitenant office building.  The tenants had not been aware the building was on the market.  For most, the first inkling was a letter that there will be a building walkthrough on Thursday morning, which they were required to accommodate per their lease.  “Per their lease” should have been a tipoff.  Several weeks later there was a notice of the building sale, followed a few weeks later by the invitation to a lunch reception in the lobby for all tenants.  An assortment of sandwiches and salads from a nearby deli.  That was the venue they first heard from their new landlord and his vision of upgrades.

The next correspondence arrived by certified mail to each of the tenants, informing them that their leases would be terminated in 90 days, necessitated by undertaking the planned renovations.  All tenants would need to sign new leases or vacate by that time.  There was an option to to move to different sized space in the building.  They were encouraged to make an appointment with the building lease manager at their earliest convenience.  Most tenants immediately checked their current leases.  Indeed, some had clauses that gave both the landlord and the tenant the option of terminating the lease without cause with 90 days’ notice.  Most leases had 6 to 18 months until their end, some with automatic rights to renew at a specified percent increase.  On those, the only right of termination by the landlord was failure to pay over 60 days.  Almost all tenants were current in their payments.

Those who seemed to have solid leases allowing occupancy past 90 days then consulted their attorneys.  There were uniform legal opinions that the terminations were unlawful.  The tenants learned of this when they started consulting each other at what became regular meetings for a few weeks in the lobby each evening at 5:00 PM.  Their respective attorneys cautioned them that fighting the termination would be expensive, and might even entail lockouts and utility terminations requiring a judge’s order to reinstate.  This legal advice ultimately led all tenants to schedule meetings with the leasing manager.

Proposed new leases had already been prepared prior to each meeting.  Unsurprisingly, the rates on those leases were somewhat higher than the current rate, justified by the need to amortize the costs of the planned upgrades.  Those who read the lease carefully discovered that the leases also had annual escalation clauses of 4.5% per year.  Later input from their accountants identified five considerations in responding to the proposed leases:

1. The first increase in square foot rental costs would be within local range for the locality once this B- building was upgraded to B+.
2. The suite calculations were now based on actual size plus a percentage allocation of common area square footage.
3. The initial increases the first and second years would likely be less costly to the tenant than the direct costs to relocate their business, which would also be a challenge in presumably less than 90 days.
4. Subsequent increases, barring high inflation, were likely high for their market but may be still less than both direct relocation costs plus indirect business disruption costs.
5. The accountants’ contacts in the commercial real estate agencies indicated that there were few vacancies in comparable B- buildings in similarly desirable areas.

Each new lease was also accompanied by a floor plan indicating the new location in the building as tenants would need to move into newly renovated suites.  These new spaces were usually about 10% larger than the current leaseholds, but often lacked the desirable locations in the building that those tenants now enjoyed.  These shifts within the facility would incur many of the move and business disruption cost as the alternative of moving to another building.

Thus began the negotiations, as the days until the landlord’s move deadline approached.  Some tenants took this opportunity to move to larger or smaller suites there or at other locations, welcoming the reprieve to duck out their current lease term.  Others agreed to forgo planned upgrades to their suites in return for a slightly lower first year rent and being allowed to retain their existing suite location.  Few pursued a strategy of filing a complaint in court and proceeding to trial on breach of their lease contract.  By the time the 90 days’ notice had passed, 80% of the tenants had agreed to mutually terminate their current lease and accept a new lease, thereby opting out of further legal recourse.  None of the existing tenants chose to stay in place and risk business disruption, forcing the landlord to spend time and expense to try to obtain a court order to have the sheriff evict them on some pretext.

Over the next few months, some tenants were relocated to different suites, not all of these being upgraded in finishes.  New tenants moved in to fill the vacated suites, many accepting lower rate terms followed by the higher rate escalations each year.  The landscaping on the exterior of the building was upgraded, offering what the realtors touted as “curb appeal.”  None of the originally promised major changes to the common areas occurred, aside from a refresh of existing finishes with similar materials.  The restrooms were never renovated to B+ quality.  Some new and existing tenants complained about this lack of follow through.  They were first told that there were supply chain issues that were delaying construction.  Later, they were reminded that these upgrades were never stipulated in their new leases.  Ultimately, the tenants decided to be relieved that they did not need to work through the dust and noise those expected renovations would have generated.

This result encouraged the landlord to pursue other B- buildings, visioning upgrades, raising rents significantly, then negotiating new leases that essentially maintained the status quo with somewhat higher rents.  Each acquisition was always followed by a reception for the existing tenants that included the landlord citing a track record of previous upscale developments and assurances of similar results in the new purchase.  Indeed, the commitment to similar results was the closest to the truth this process ever achieved.  And the landlord did eventually acquire enough existing facilities to reach a million square feet in commercial real sate holdings.