No matter how diligent your business leaders are about planning for the future, sometimes the unexpected happens. Business needs can change, which may be an issue if you are in the middle of a lengthy lease term. Fortunately, there are several strategies that your business can consider if you find yourself long (or short) on space and want to optimize your spending.
1. Rightsizing Options
Downsizing is simply finding a solution with your landlord to lower your square footage. The easiest way to downsize is through a pre-negotiated contraction option within your lease. This lease term provides your company the option to contract square footage mid-lease. This could be a one-time option at a specific date or an ongoing option throughout the term.
If your business wants to downsize but does not have a contraction option, it’s still worth a conversation with your landlord. Particularly during times of economic distress or other extenuating circumstances, a landlord may be willing to work out a solution. In most situations, in order for a landlord to consider a downsize, they will look for the tenant to provide additional lease term in exchange for the reduced square footage.
Some factors your landlord might use to determine their willingness to downsize are whether or not they have another group that can fill that space quickly. What is the demand for that space, and can it be easily converted for a new tenant? Another option they may consider is if there are other suites available within your building that could accommodate your lower square footage. If so, the landlord may be able to relocate you and market the larger space.
2. Rent Deferment
Rent deferment is taking a period of your regular rental payments and pushing them to a further date in your lease. A business might ask their landlord for rent deferment during times of uncertainty or financial hardship or if they are looking for a way to minimize their expenses for a brief period.
There are a few key things to keep in mind when considering rent deferment. First off, it will likely be for a shorter term, anywhere from 2-6 months, rather than years of lease payments. It’s seen as a short-term solution to bridge the gap while a company achieves financial wellness again.
Rent deferment can happen a few different ways. It can be amortized into future rents, spread out as an additional cost in future lease months, or it can be traded for additional months of term on the back end of a lease. Landlords are generally open to the option of rent deferment to maintain their tenants, but they will still want to be paid in full for the rent that is due. It is not rent forgiveness, and the amount of rent deferred will still need to be paid in full by the end of the lease term.
3. Lease Buyout
A lease buyout is when a business pays a sum of money to their landlord to buy out of their lease obligation for a space. Your business might be considering this option if you’re shutting down the office, the space doesn’t work for you, or you just want out of the space and don’t want to hassle with a sublease.
Regardless of the reason, lease buyouts are always subject to landlord approval. The landlord will have their own motivations as to why they may or may not entertain a buyout offer. But ultimately it’s up to their discretion.
The key thing to keep in mind for a lease buyout is that it requires a considerable amount of capital at the time of the buyout. The lump sum amount will be calculated based on the remaining financial obligation of your lease. It can be anywhere from 80-95% of that total cost. Because of the large financial impact of the buyout, this strategy is not utilized often. But it is still an option worth exploring for your business. The total cash output of the buyout will typically still be less money than what you would pay over the length of your lease term.
4. Subleasing
A sublease is when you re-let all or part of your leased space to a third party. A company may consider a sublease if they have too much space and want to downsize or need to relocate to a larger space to accommodate growth. In either case, subleasing is a way for business owners to reduce the cost of unused or unwanted space.
There are a few key things to note when considering subletting your space. First, make sure you have the right to sublease. It’s not a universal lease right, but rather something that is negotiated. Review your lease carefully to understand your rights for subleasing and if there are any restrictions to those rights.
Second, it’s unlikely you will recoup 100% of your rental cost through a sublease. Savings typically range from 55%-70% of your remaining obligation when you factor in lower sublease rental rates, landlord and legal review fees, and brokerage fees. Keep in mind, even if you do sublease your space, you are still legally obligated to continue paying rental expenses on your space through the duration of the term.
Finally, subleases are often subject to landlord approval. The potential subtenant will have to have good standing credit and fit within the restrictions set forth in your lease language. Again, review your lease language carefully to fully understand your options.
5. Lease Termination
A termination option is a pre-negotiated lease term that allows a business to end their lease prior to the expiration date with pre-determinate financial terms. This could be a one time-right at a specific date or an ongoing right after a portion of lease term has passed.
Termination options are great for businesses because it gives you the flexibility to get out of your lease commitment if you need to relocate to a different size space or location, or simply get out of your lease. Even if you’re happy with your space, it’s a good leverage point mid-lease to reevaluate your needs and start a conversation with your landlord.
If you have a termination option, a landlord will want ample notice before the effective termination date. Usually, it will be 9 to 12 months before the actual date. Termination options are almost always accompanied by a fee. The fee is a combination of unamortized lease costs offered at the beginning of the term, such as free rent, tenant improvement allowance, and brokerage fees at an interest rate of 6-8%. This fee is a lump sum due at the same time you deliver your notice to terminate or at the termination date.
Negotiating for a termination right is achievable, but it’s a big concession for landlords whose building value is based on guaranteed lease term. If they are planning on selling or refinancing or there is high demand for space in their building, they may be less likely to agree to a termination option.