As discussed in our March Newsletter, increasing Lease Spreads are impacting the commercial real estate market nationwide. When your lease is up for renewal, expect that rent will be going up- and it may be significant. Tenants in the following situations are especially at risk for larger than average lease rate increases:
– buildings that recently sold or have sold after the lease renewal
– tenants with long term leases and/or options that are expiring in the near future
– older buildings that were traditionally harder to lease
– Buildings located in secondary markets
Wisconsin has traditionally been a very stagnant market in terms of rent growth. The old days of tenants entering a renegotiation with the expectation of a rent reduction are no longer. Record demand, inflation, and construction costs have aligned to push rents nationwide. Strategies for tenants to navigate this environment are below
For Existing Leases or renewals:
1. Does your current lease have an option to extend? An option to extend with stated lease rates is the golden ticket. Do not let that expire! Not all options are created equal but having one is an excellent first step
2. Does your current lease limit NNN escalations? Factors including inflation, if the building sold, and reassessment can add substantial additional costs to the lease. Sometimes these additional charges have limits to the increase, it is worth checking
3. Does the current lease allow a Subtenant? In some leases the tenant can actually make money on a sublease. This clause can be very important especially if there are options to extend. This can actually provide the tenant with leverage or an opportunity to profit by renting out the space at market rates
4. Know your landlord. Better yet know your Landlord’s motivation. If a REIT or pension fund owns the property, well good luck. These groups typically know the market and will demand either market rate (possible very large increase) or try to set the market by pushing rents over the most recent deals. Local ownership, however, might be more concerned about raising interest rates and the general economy. They may be more willing to grant an easy extension rather than demanding the large increase
5. Blend and Extend. This works best if the current lease has some term left. The basic concept is to extend the lease, but agree to a rate higher than your contract rent. The upside is you avoid the big rent increase by agreeing to a bit higher rent up front but getting moderate increases over the extended term.
For New Leases:
1. Short term leases are not your friend! Many tenants in the past pushed for short term leases. Many of these tenants are now realizing the downside. A longer lease will provide more certainty in the future. Many landlords have been loving short term leases as they have been able to ride the wave of increasing rents rather than fixing rent at traditionally lower increase levels
2. Try for options to extend. See #1 above. A well designed option structure is a tenant’s best friend!
3. Be careful with automatic CPI (Consumer Price Index) Increases. Many tenants have agreed to these in the past because the index was hovering around 2%. CPI jumped 7.5% from January 2021-2022 and an additional 6.5% in 2023.
For All Tenants:
1. Engage a qualified Commercial Real Estate Broker. Big surprise here! But seriously, vacancy rates in the most populated areas in Wisconsin are at or near record lows. This is a big time Landlord market. Many companies find that the task of finding a space on their own is nearly a full time commitment. Any advice you can have to tilt the scale in your favor will be well worth it
2. Review your facility needs. Rent is going up or is likely more expensive than you think. We discussed that short term leases are not in the tenant’s favor. So if a business will be committing to the space for some time it is the best time to evaluate the business’s needs. The old building may not be the value it was when the business moved in. If you are committing to a new lease it is the right time to make sure the facility is right
3. Start looking early. Vacancy in some markets is under 1%. This means that the building or space a tenant needs is likely not on the market. Tenants need to plan out and be ready to jump on the right deal. Starting a search 12 months before lease expiration is the minimum timeline in this market
If you are interested to know more please reach out to Mark@Summit-CRE.com or 262-370-9852