We find Tenants have difficulty understanding why a sophisticated Landlord will not “drop their pants” negotiating lease rates with new and existing tenants, even when a property may appear to be in distress. Let me explain why this counter intuitive statement is, in most cases, true.
True life example
I can best illustrate this by using an example. We currently have a large commercial property listed for lease in a secondary Saskatchewan market with approximately 70% vacancy. The anchor tenant relocated into a new development last year. The owners have since spent a significant amount of capital updating the property. Many Saskatchewan commercial real estate property owners hold a few properties in their portfolio, as is the case in this example. This provides for income stability if one property within their portfolio is under-performing and allows owners to make business decisions based on long term goals rather than overreacting to immediate fiscal challenges.
How asset value can be impacted
One of the most common methods of determining the asset value of commercial real estate is called the Income Approach. A capitalization rate is applied to net income to come up with the market value. Even a $1.00 or $2.00 reduction in net rent (see Leasing 101) can negatively impact the value in a significant way. Many times these net lease rates are negotiated and fixed for 5 or more years. This obviously impacts a property owner’s position if there are plans to either sell or refinance the property in the foreseeable future.
Neighbors can say too much
There are other considerations when the Landlord in this example either negotiates a lease with a new tenant, or a renewal with an existing tenant. There is absolutely no guarantee that the rate that is finally agreed to will be kept in confidence by that tenant. There are consequences If the landlord agrees to contract a tenant at a below market value rate. It can happen that a tenant discloses the negotiated number to either a prospective new tenant or existing tenant. Once that rate becomes known, it can be very difficult to bring the negotiation with the next party back to a market number.
The moral of the story is…. ask questions! There certainly may be occasions when a “low-ball” is the right approach. Don’t make assumptions until you know the circumstances and strategies of the party you are negotiating with.
Posted by Barry Stuart