The idea of terminating your warehouse lease that you don’t need anymore may seem straightforward. That might be the case if we were talking about the apartment lease you had after you graduated from university. There you could just pay $500 and walk away.
With commercial contracts, however, when you decide you want to terminate the lease, there could be $120,000 per month left on your commitment over the next eight years. That means that the landlord would forgo $10,600,000 by allowing you to terminate the lease. How much do you think would be fair to compensate the landlord for this lease termination? Would the $150,000 security deposit be substantial enough? What if your landlord’s loan only had two years left? What if the landlord pitched in $500,000 to build out the exact way you wanted it built?
Here are a few scenarios that help you understand what is possible.
In practice, it is a rare occurrence that a company signs a long-term lease and can obtain the right to terminate the lease at some period in time in the future. In most cases, this right to terminate may be allowed after the initial 3-5 years and at the cost of 3-6 months’ worth of rent paid at the time of termination, plus the repayment of all unamortized expenses. Unamortized expenses are the term for the payback of any expense that the landlord incurred to induce the tenant to sign the lease. If there is the right to terminate a hypothetical ten-year lease, at the end of year five, the tenant would have to pay back 50% of the tenant improvement costs, leasing commission, and any other expenses that may include demolition, permitting, signage, etc.
There is also a notice window, whereby the tenant must give the landlord notice to terminate the lease. The reason for the advanced notice is that the landlord needs time to market the building and find a replacement tenant, all without the building being vacant. This time is negotiable and can be between 6-12 months in most cases.
The amount of time, effort, expense, and vacancy that takes place with each lease is large enough that it most likely won’t result in a lease termination shorter than seven years. Remember, leasing industrial buildings can be expensive with downtime, commissions, and constructing tenant improvements, especially if it is an older building or in a suburban or tertiary market. The breakeven period for most landlords is several months up to one or two years in larger deals.
One of my favorite ways to add value to clients is in the subleasing and termination of their leases. The perfect world outcome is to be able to market a client’s buildings for sublease, find a new tenant who wants to lease the building for a longer-term than we have left on our original lease, and pay the same rent or higher. When I find this tenant for my client, we end up taking this tenant to the landlord and helping the landlord lease the building to the new tenant directly in exchange for terminating my client’s existing lease.
Why would a landlord do this? The reason is that we are providing value to the landlord directly. If we can provide enough value to the landlord, then they will find the opportunity worth the time and effort to sign the new tenant and terminate my client’s lease. The lease termination then frees up my client to move on to their new building and refocus on growing their company.
The last thing any business executive wants is to sublease their space to a company only to have that sublessee run into problems and vacate the property. If you sublease your old building to a new tenant, and that new tenant doesn’t pay the rent, you pay the rent. Nobody wants to pay the rent for two buildings. Some companies cannot afford to do this, or at least not for an extended amount of time. The cost of subleasing is why turning a sublease into a lease termination is so valuable to both the sublessor and the master lessor alike.
I recently worked for a long-time client who has operations in Memphis, Tennessee, and Cerritos, California. We worked together several times on extending their warehouse leases. This client had one large client on the West Coast that they did so much business with that it necessitated a warehouse dedicated to this customer. On our first assignment, the client and I negotiated a new dishwasher in the break room for the employees, a full remodel, and warehouse floor repairs, before settling on three additional months of free rent. On the next lease renewal negotiation, I was able to help the company executive’s team while the principal business owner was undergoing a long-awaited surgery that required extended rehabilitation and physical therapy. This experience helped me appreciate the group that this executive had built around him that was able to operate at the highest level during his absence. Years later, after all of these bonding experiences, the company’s primary customer sold their business to a larger computer company. This new computer company decided that they didn’t need my client to fulfill their distribution any longer as this new corporate parent was so big, they had logistic capabilities in-house. But we were at the beginning of our new five-year lease! Again, business cycles and real estate cycles rarely fully synchronize.
In this instance, we were able to market the client’s space for sublease. We uncovered multiple interested parties, leveraged those proposals with the client’s neighbor, then negotiated an expansion with our neighbor. This neighbor had the same landlord as us, which created the perfect opportunity for us to terminate our lease. This lease termination freed my client up from the overhead expense, reduced the stress of wondering if his neighbor was going to pay the rent each month, and allowed him to pivot his company to focus on greener pastures. We were also able to sell the furniture to the new tenant so that we did not have to incur the expense to move it back to the corporate office.