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Your Option to Renew

When you moved to your current office space, you likely invested considerable time and money to optimize design, complete renovations, purchase furniture, and set up an IT network to suit your business requirements.  In an effort to protect your interest in the space, you likely also negotiated an option to renew, to avoid having to move and repeat the process at the end of your lease.

Filed away and forgotten

More often than not, tenants sign their lease, file it away, check that box on their to-do-list and completely forget about it.  Why re-visit all that legal mumbo jumbo?  It is not exactly a page turner!  However, it’s important not to completely forget about your lease, since it contains critical dates, like the notice period.

A Critical Date

If you review your option to renew, there will be a notice period defined in the language.  Typically, if you plan to exercise your option to renew, you have to let your landlord know a certain number of months prior to the expiry of the term.  Based on the wording of your lease, you may have to provide anywhere from 6 to 12 months written notice.  If you miss the notice period date, your option to renew is gone, and the landlord has the right to start marketing your office space for lease.

What Can Happen?

So, what happens if you forgot about your notice date, or simply didn’t respond?  Don’t panic.  Your landlord likely wants you to stay, and won’t lease your space to someone new without confirming if you want to renew your lease.  It’s always a lot less expensive for a landlord to renew a tenant’s lease than to find a new tenant.  That said, there are scenarios where your landlord may want to lease your space to another tenant.  For example, what if a much larger tenant in the building needs expansion space?  If you were the landlord, would you tell the larger tenant that you can’t accommodate their growth and risk they leave, or would you try to free up space in the building? Your landlord is likely a good person but he or she is also running a business.  Personally, if I was in his or her shoes, I would aim to accommodate the larger tenant, even if that meant forcing a smaller tenant to relocate.

Recommendations

To ensure you don’t let your option to renew slip away, you should consider the following recommendations:

1.  Create a lease summary highlighting critical dates like your notice period;

2.  Set a calendar alert or reminder of critical dates;

3.  Consider preparing your renewal notice in advance and append it to your lease.

Think of it as part of a bigger leasing strategy that aims to protect your interest in your space, and avoid unnecessary, last minute scrambling if you are forced to relocate.  It’s just good business.  If you don’t have the time or interest to take these steps, request a lease summary from your lawyer, or outsource it to a broker (for free).

For questions, comments, assistance, or a lease summary, please contact me directly.

Navigating a Lease Renewal

If you are approaching the end of your lease, the path of least resistance is to accept the Landlord’s proposed rent and lease terms, to forgo any inducements, and to simply renew.

Before you take this route, you should consider what your Landlord stands to lose if you don’t renew your lease.  If you relocate, your landlord will have a loss of income while trying to secure a new tenant.  In this market, any incoming tenant will likely be paying discounted rent, and benefit from inducements like free rent and an improvement allowance.  It is far more profitable for your landlord if you renew your lease.  Your tenancy is valuable, and you should view it that way.

If you are considering a lease renewal, I recommend that you think about following 6 points before signing:

1. Start Early

It takes time to review your needs, project your space requirements, survey the market for options, negotiate an offer and lease, and complete renovations.  If you don’t start a minimum of 8-12 months in advance of your lease expiry, you can compromise the leverage for a lease renewal negotiation, and ultimately the quality of your office space.

2. Run a process

Your landlord knows the market and the tenants that are ‘on the street’ looking for office space.  You need to invest time in a process that explores the different competitive options.  You may be surprised at the opportunities that are available.

3. Make it competitive

Always request a proposal from your landlord, and other landlords.  This isn’t just for leverage. It is always wise to have a plan B…and plan C.

4. Limit communication

Leverage during negotiations slips away quickly when you, or a staff member, disclose your position.  Even an inadvertent comment to the building manager or leasing representative can jeopardize your position in a negotiation.

5. It’s a business decision

Relationships are important, but at the end of the day, the potential business terms of the renewal are going to drive the decisions.  Just because you have been in the building for many years and established a relationship with the landlord doesn’t mean you are guaranteed the best deal.  In fact, your landlord knows the longer you have been with them, the less likely you will be to relocate.

6. Outsource

I know it seems self serving coming from a real estate agent, but letting an agent, active in office leasing, run a transparent process goes a long way to arriving at the best deal.  When your landlord knows you are working with a credible agent, they know that you are going to have competitive options.  Unless you can devote significant time and your full attention to completing a lease transaction, and you are fully aware of all possible opportunities in your market, you are likely to leave savings and favorable conditions “on the table”.

Is that a Capital Cost of an Operating Expense?

In a previous post, I wrote about passthrough costs that exist in ‘Net leases’ (most leases in Ottawa). In brief, these are expenses related to the operation of your building passed through to you by your landlord. Operating expenses typically include utilities, maintenance and repair, janitorial services, snow removal / landscaping, etc. and make up your additional rent. In essence, they are expenses that were paid during that year to run and maintain the building.

Another type of expense landlords face are called Capital costs. Capital costs are incurred when acquiring, replacing or completing major repairs to a building and / or the equipment servicing the building. Basically, these are renovations or upgrades to things which create long lasting value such as the building structure / roof or major mechanical systems including the elevators, escalators, heating, ventilation and air conditioning system (HVAC).

 

Why the Distinction is Important

Understanding the distinction between Capital Costs and Operating Expenses is extremely important. Fluctuations in operating expenses, like electricity or property taxes, generally result in invoices / rebates for nominal amounts equivalent to a few cents per sq. ft. of rentable area. However, Capital costs can amount to hundreds of thousands of dollars, and if passed through to tenants, can spike the additional rent dramatically.

 

A Contentious Topic

Landlords are in business to generate profit and increase the value of their buildings, as you or I would if in their shoes. This is done by increasing net (aka base or minimum) rent and passing through as many costs as possible to tenants. Some landlords feel that as a tenant, you are benefiting from renovations and upgrades, so you should pay a portion of these costs.

As a tenant, you likely feel that the net rent you pay should cover the cost of major repairs and replacements of ‘big ticket’ equipment and components of a building. These items are owned by the landlord, not by the tenant. If the improvements provide a benefit to the landlord beyond the term of the lease, they should be at the landlord’s expense.

 

So Who Pays What?

It really comes down to the wording of the lease. That said, many Ottawa landlord’s will follow ‘generally accepted accounting principles’ when addressing Capital Costs. As such, if a cost is incurred to increase the life of a building, or improve its service delivery to a tenant, it is the Landlord’s cost. For example, replacing the building elevators or upgrading the rooftop chillers that cool the building.  When costs are incurred to maintain a building, or the building’s structure, such maintenance costs can be passed through to the tenant via additional rent. For example, repairs to the building roof or building lighting.

When capital expenses are not clearly defined in a lease, a landlord may have more discretion as to what is passed through to a tenant. In these situations, tenants can end up paying for ‘repairs’ that may otherwise be considered capital costs. To make matters worse, capital costs may even be included in the operating expenses.

 

Recommendations

The distinction between Capital Costs and Expenses is complicated. A detailed overview of the issue is far beyond the scope of this post, and better addressed by your accountant or lawyer. However, here are a few recommendations that may help:

1.  Renovations – if renovations are planned for the building, be sure to ask about the timing and how the cost of the renovations will impact the operating expenses;

 

2.  Historical Expenses – ask to review the operating expenses for several prior years to confirm if there have been any dramatic spikes;

 

3.  Legal Review – the language concerning operating expenses, and the definition of Capital Costs in your lease, should be vetted by a lawyer to limit your exposure;

 

4.  Cap escalations – if you have the leverage, try to cap the operating expense escalations;

 

5.  Right to Audit – this right (not obligation) will allow you to audit the operating records for the building and ensure that you are only being charged for items included in your lease.

 

Ultimately, despite your best efforts and negotiating, you may have to accept that capital costs, or a portion thereof, will be passed through to you. It really comes down to the individual landlord and the amount of leverage you have in the negotiation. Asking the right questions up front, and addressing the language in the lease, can reduce the odds a nasty passthrough cost as a surprise down the road.

For questions, comments, or assistance please contact me directly.

The Sublease

There are always sublease opportunities in the Ottawa market.  Subleases can represent great value for a subtenant but there are risks that need to be considered as well.

 The Direct Lease

When a company signs a lease for “direct space”, they enter into an agreement with the landlord’s company.  The majority of office leases in Ottawa are direct leases, meaning, they are signed directly with the landlord of the building

 The Sublease

As you may have experienced, or can likely predict, if a company outgrows their office space and needs to relocate, or has excess office space during the lease term, they often try to sublease their space.  In a sublease, unlike a lease for direct space, the two parties who sign the sublease agreement are the existing tenant or “sub-landlord” and the new tenant or “subtenant”.

 Review the Head Lease

The direct lease between the Landlord and the sublandlord is considered the head lease and is superior to a sublease agreement.  As a result, sublandlords and subtenants should be aware of the terms and conditions in the agreement before marketing, or subleasing their office space.

 The Added Value for Subtenant’s

- Sublets are typically discounted below market rent to attract prospective tenants.  The benefit for the sublandord is the ability to recapture rent and / or effectively walk away from a leasehold obligation.

- There can be great value in leasehold improvements that haven’t experienced the wear-and-tear of a full lease term.

- There may be an opportunity to take over completely furnished, and pre-wired office space saving thousands of dollars.

- Finally, for many subtenant’s there is the added benefit of a shorter term commitments then they would typically have in   a lease for direct space with a landlord.

 You Will Need the Landlord’s Consent

In Ottawa, a sublet is generally contingent on the landlord of the building giving consent and approval for the new subtenant, prior to the execution of a sublease.  The landlord may have the right to decide, acting reasonably, if they approve of the subtenant’s intended use of the space, the nature of their business, and their financial covenant.

 Remember The Risk

The single biggest risk that a subtenant has is that the sublandlord stops paying rent.  If the Sublandlord is in default, and the landlord terminates the head lease (the lease between the landlord and sublandlord), the landlord can literally lock the doors.  If this happens, the subtenant’s rights to the space cease to exist, regardless if they had been paying their rent.

 Leaseholds

It is rare that a sublandlord is willing to provide an leasehold improvement allowance for a subtenant to make changes to a space.  Often the cost of improvements can be offset with free rent from the sublandlord but, for cashflow sensitive prospective subtenants, this may not be an option.  The good news is that you can likely negotiate a longer term lease with the landlord, rolling the discounted sublease rent into a new longer lease term that has the leasehold improvement allowance need for modifications of the space.

Ultimately, there is great value in subleasing office space if common interests align.  There are always ways to structure a sublease agreement to minimize risk to both sides.  Just be sure you enter a sublease knowing all the facts.

To discuss the value of your leasehold interest, how to market a sublease, and existing sublease opportunities please contact me directly.

5 Things That Impact the Quality of Office Space

Early this year I posed the question, “what makes good office space”.  I was searching for evidence based information on the qualities of office space that people want to work in; the type of office space that improves work flow; the type of office space that enhances productivity.  Although I am not an architect or an interior designer (my office space sketches are evidence of this), I am a guy who spends a lot time thinking about office space.  Here are five things that I believe really impact the quality of office space: 

1. Privacy

People need private space.  How office users define their privacy depends greatly on the nature of their work.  On one side of the spectrum, there are the cross functional, collaborative based teams.  On the other side of the spectrum, there are focused, confidential, individual based tasks.  The nature of our work influences our perception of privacy.  Some tasks require the complete acoustic and visual privacy of an enclosed office, while others can be completed in open concept, free flowing spaces.  Regardless of how privacy is accomplished, good office space has to a have sufficient areas for privacy.

2. Noise pollution

Sound based disruption, or ‘noise pollution’, is a problem.  Office noise pollution is distracting and disruptive.   The good news is that there are potential solutions for the common causes of office noise pollution.

3. Natural light

Everyone needs exposure to natural light…even if they are glued to their screens the entire work day.  In brief, office workers who have natural light throughout the day sleep 46 more minutes a night.  This is a significant amount of sleep and has implications for general health, as well as productivity.  Here are 6 ways to improve natural light in office space.

4. Indoor air quality

Indoor air quality (IAQ) is often overlooked when considering the office space.   It can be a mistake to assume that all office spaces are are created equal and are performing at the same level.  Fresh air supply and indoor air contaminants can impact health and productivity.  Here are the common causes of poor indoor air quality and ways to improve office indoor air quality.

5. Accessible amenities

I don’t think anyone will deny that there is greater demand for office space that is close to amenities.  That said, if getting to those amenities takes more than a 5 minute walk (400m+/-), they probably won’t be used nearly as often as you may think.

The good news is that with proper planning, a little leg work, due diligence, and the involvement of the right professionals, you can rectify issues with your current space or simply find better office space!

For general questions about Ottawa office space, and office leasing, please refer to my ‘common questions‘ page or contact me directly.

 

 

 

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