My new client, the CEO of a national distributor of automotive products, faced a downturn in the market. “We have to downsize to a smaller warehouse,” he said. It was a knee-jerk response to what he thought was a straightforward situation.
“Not so fast,” I said when he hired me.
We had a long conversation in which we went over every detail of his lease agreement. He then discussed the ins and outs of laying out a new warehouse with his VP of operations. We reviewed the market, the vacancy rates, and the outlook for his industry.
In doing so, we realized relocation was not the answer. It was far more economical for this company to find a subtenant for part of their space than it was to move and set up their operation in a totally different spot. In fact, it was $350,000 cheaper. Plus, if the company moved to a smaller space, it would have no flexibility to expand again when the market turned around.
A thorough review of all of these factors led to a solution that cost my client a one-time $18,000 cash outlay but reduced his cash flow lease expense by almost $13,000 per month. This left his company in a position to weather the storm and be ready to grow again when the time was right. All of this occurred because this CEO stepped back, took a review of his operations, and made an educated, strategic decision.
In this chapter, we will lay out the steps that will give you a firm foundation for your commercial real estate decisions. We will discuss how you can review your lease, your property, and your current operations. Then we will discuss how you can assess all of these against the dynamics of the current market. We will not discuss hiring a broker until Chapter 5, but it bears mentioning that seasoned executives usually engage their broker with the inception of a new vision, as their broker will bring insight and raw data to the table. This will help executives size up how a potential real estate project fits into their initial feasibility.
START WITH THE ENTIRE LEASE DOCUMENT
The lease contract is the list of rights and responsibilities the tenant and landlord have during a specific time. Reviewing the lease document will allow you to analyze your company’s rights and financial obligations. Unfortunately, getting a copy is sometimes a struggle. The full document might be a compilation of papers that have passed through several caretakers over a number of years. You may have a hard copy in a file cabinet, an electronic copy, or you might have a software system populated with all of the pertinent information. You might have to ask your broker to ask your landlord for a copy, and you would not be the first. Some tenants have me do this without explicitly telling the landlord they have misplaced their documents and do not know all of their own lease details.
What is important is that you review the entire agreement. Check to make sure you have the initial lease, the first, second, and subsequent addendums, and any work letters. Changes are often made in subsequent agreements, such as roof repairs, months of free rent in exchange for extensions, and so forth. Also collect records of large repairs, replacements, and security deposits. You want to make sure you know about everything, especially agreements that might date back to before your time in charge of your company and its real estate. For example, you might be new to the company, and the person who negotiated the original lease may have left years ago. Your old landlord may have sold the building, and your new landlord was not the one who signed that first lease. This ambiguity can create friction and misunderstanding, and you want to avoid both as much as possible.
Recently, I was hired by a landlord to clean up a decades-old real estate mess. She had inherited a handful of industrial buildings in Costa Mesa, California, from her mother. The mother took charge of the property after the death of her father, the original purchaser of the property. Over twenty years, the security deposit had increased, been credited back, and increased again. Then, in a subsequent extension, the security deposit was omitted, and in the last extension it was handwritten illegibly on the contract at an unknown time. What is more, the tenants’ records were worse than the landlord’s. In the end, we were able to negotiate a good place for both parties and remove the potential for future ambiguity, but the lesson remains. Get your documents in order first.
REVIEW THE LEASE
The goal of reviewing your lease is to have clarity about the remaining obligations for you and your landlord. You also want to know if there are any outstanding credits or debits to your account.
Lease review objectives:
- Double-check the original commencement date.
- Review each lease extension.
- Double-check the rent figures with your accounting records.
- Review the changes made during each extension that modify the original lease document.
- Verify the security deposit amount.
- Confirm the lease expiration date.
- Understand the renewal notice date.
- Read through your options to further extend the lease, and make sure you are aware of the option rental adjustment terms.
- Identify the penalty for remaining in the property after the lease expires in the Holdover section.
- Understand any requirements relative to moving out of your existing space.
Several of my clients have reviewed their leases, only to find their leases started upon substantial completion of their tenant improvements, which occurred years ago. They do not remember what month it was exactly, and the lease does not say. The lease commencement memorandum was not saved in the file, since it was signed four months after the initial lease signing.
After you have reviewed the lease, make a list of outstanding issues and concerns. For example, was there a maintenance request that never resulted in a satisfactory repair? Does the lease state you have to repave the parking lot or replace the roof before you move out?
REVIEW THE PROPERTY’S PHYSICAL CONDITION
Next, assess the physical condition of the property inside and out, top to bottom, front to back. Start with the office and move to the warehouse. Look at the ceiling, walls, and floors in each space. Then walk around the outside of the building. Look at the landscaping, the parking lot, the truck court, the drainage areas, the roof drain spouts, the joints in the tilt-up panel, the dock doors, the dock bumpers, the truck well sump pump, the roll-up doors, and everything else.
Think of this like the moment you pick up your rental car during a summer vacation to Maui. What does the rental car company do? They have you sign off on the condition of the car.
They inspect the car by walking around it and making note of any damage. If you do not see any damage then, but you have damage when you return it, it is your damage.
Your property is really just a large rental car! Think about its condition when you first moved into the building. If you cannot remember or you were not there, simply evaluate it as though everything is in good working order right now, because that is the condition the property will need to be in when you return it. Discuss your internal expectations for normal wear and tear with your colleagues.
If you decide you would rather not move, you will use this assessment to help the landlord understand the improvements that are necessary for you to extend your lease.
REVIEW YOUR OPERATIONS
What are your future goals for your company? Talk with your operations and management leaders about how your current operation fits into the existing facility. Your COO, VP of operations, general manager, and facilities managers are great people to start with, and the more feedback you get, the more nuances you will understand.
How do your team members feel about the layout of the office space? What image do they think it portrays to customers? What do they like, and why? What would they do differently if they were to design it from scratch?
You will likely get more feedback than you expect, because every employee will find this discussion relevant. Some office workers might tell you, for instance, that the thermostat is oriented in a way that makes them run cold every day, and they have to bring in space heaters. Others might tell you they feel closed off because of the way the private offices are laid out, or they are lacking natural light. No building is perfect, but it is helpful to hear your team’s feedback and understand their needs.
When you turn your focus to the warehouse, you should focus on its flow. Your operational concerns will depend largely on your industry, but you likely need to get materials to the building, bring those materials inside the loading bay, and move them within the warehouse to where these materials are stored. Then those materials are either assembled, consolidated, broken down, picked, refrigerated, tested, sewn, printed on, packaged, or palletized, and then stored again. Finally, these finished products are taken out of the building, put on a truck, and taken to customers. When discussing flow with your team, ask them what is working well for each component of this path and what needs to be improved. Here are some questions that always elicit powerful feedback:
- Where are the bottlenecks or friction points?
- If you had to design the facility all over again, how would you do it?
- If you could have any improvement in this operation, what would be the highest priority?
- What are your current and forecasted operational metrics?
REVIEW THE MARKET
Your broker should provide a brief overview of the market. This is the gut check whereby you can understand how well your initial intentions line up with the realities of the market. If you find there are plenty of properties available that fit your need and budget, you will have the confidence you need to proceed. On the other hand, if you find that your needs will only be satisfied by finding a needle in a haystack, you might want to think about budgeting extra time, looking in a larger geographic area, revising your budget, or renewing and forgoing a relocation at this point in time.
It is likely, at this early stage, that the properties available now will not be the same properties available once you are ready to engage in the market, but this property availability review still provides insight into what the current market environ- ment looks like. By dipping your toe into the market, you will learn what kind of incentives are being negotiated and what the market velocity is.
This completes your first pass of situational awareness. You should have a fresh perspective on your current lease, property, operations, and the market. You will feel more informed and able to think clearly about what to do next.
You have now tracked down all of your lease documents, walked your building, talked with your team, and taken a look at the market. Now, armed with all of the background you need to ensure your success, you can move forward and start planning your company’s future.