Utilizing Global Market Conditions to Reduce Occupancy Costs

Utilizing Global Market Conditions to Reduce Occupancy Costs

API Global Improves Clients Bottom Line

The Opportunity

Corporate real estate costs represent one of the largest operating expenses for companies. Companies today are always on the lookout for practical ways of reducing these costs. By utilizing a proactive cost reduction program, companies can achieve savings while increasing shareholder value.

The Financial Standards Board, which sets financial standards for US companies, recently announced companies will be required to report all leases as assets versus liabilities on their balance sheets beginning in 2013. This change will have a major impact on companies trying to improve their financial performance in a sluggish economy.

The Global Rental Market

Rental rates have declined in many global markets over the past five years, but will begin to increase as the global economy improves. Now is the optimum time to renegotiate leases using today’s pro-tenant market conditions. Waiting until the lease expiration date to manage the renewal process will leave the unprepared tenant paying increased occupancy costs.

The Challenge

Many companies assume an existing lease with 1-3 years remaining on the term cannot be renegotiated until the lease is due to expire. Historically, this has been the case with most landlords offering no relief outside of the terms of the lease agreement. In the current global economy, landlords watch helplessly as their local market rents drop and vacancies increase. This situation has created pressure on landlords to be flexible on terms in order to retain their tenants. Landlords hate to lose tenants regardless of their size especially good tenants. Managing an early restructuring can pay dividends given these conditions.

Understanding the Landlord’s World

Like corporations, landlords are accountable to their banks and investors as it relates to the value of the buildings (asset) they own and manage. To get the maximum return on investment from the asset they must get fair market rental rates or better and keep the building fully occupied. Since buildings are valued by the amount of annual rent and the length of the lease terms, a vacant office has a negative impact on the value of the asset so landlords are highly motivated to keep tenants even if it means offering below market concessions for a renewal.

If a tenant vacates the building when their lease expires it can take as long as 4-6 months or longer to secure a new tenant. The landlord’s cost to attract a new tenant may include a broker’s commission, free rent and tenant improvements which in addition to the lost rental income during the vacancy adds to the landlords total loss. The cost of losing a tenant is especially severe in a down market so it is in the landlords best interest to find ways to keep the tenant happy and feeling like they are paying a fair market rate for the space when they request to renegotiate an early renewal and extend their lease by a few years.

Early Lease Renewal Process

Renewing an existing lease 1-2 years before the expiration date is a good way to reduce your occupancy costs and utilize the current market conditions to your advantage, now is an excellent time to renew and extend your lease. A successful lease renewal requires proper due diligence with access to reliable market information and adequate time to manage the process. Depending on the landlord’s situation in the market as well as geography, this process varies in the degree of challenges so API Global recommends tenants start the process no less than one (1) year before their expiration or renewal date.

To begin this process, API Global suggests compiling the following information before meeting with the landlord:

  • Current market report
  • Lease quotes from other landlords
  • Financial analysis of alternatives

When negotiating an early renewal it is recommended that a tenant take the remaining term of the lease such as 18 months and offer the landlord a new 36 month lease at the current market rate. This offers the landlord the ability to keep a tenant and increase the lease term at a lower monthly rent. By reducing the rental rate, the deposit will also be lowered and refunded since the deposit is calculated based on the monthly rental rate.

Sample of Occupancy Savings

Tokyo Japan,
Lease term remaining: 12 months
Existing Lease New Lease Savings
Space 7,500 7,500 -
Original Lease Term 24 months 24 months -
Current Rental Rate/SF/Month $7.50 $4.75 $2.75
Deposit (6 months) $337,500 $213,750 $123,750
Total Rent/Term $1,350,000 $855,000 $495,000
Total Financial Obligation $1,687,500 $1,068,750 $618,750
Reduction Of Occupancy Cost 36.67%

Alternative Methods of Reducing Costs

International leases require the tenant to pay rent as well as a monthly maintenance charge called Common Area Maintenance (CAM). The CAM charges are typically estimated by the landlord based on historical data. In many cases, tenants pay these charges for the term of their lease without ever auditing the landlords’ actual costs or the method used to calculate their share of these costs.

In the lease agreement the space leased is represented by two numbers: the total rentable area that will be charged to the tenant and the actual usable area the tenant will be occupying. The difference between the rentable and usable numbers can represent as much as a 30% increase. For example, in China if a tenant needs 7,000sf of usable space they may be required to lease 10,000sf. This additional space is considered the tenants share of the total building factoring in common areas such as lobbies, restrooms, circulation areas, etc.

If the landlord does not measure the usable area accurately, the tenant will end up paying rent, deposits and CAM charges for space they do not actually lease and this represents a significant overcharge over a three to five year lease. API Global will audit the landlord’s building plans to verify the actual space so that we can get the tenant a refund on rent, deposit and CAM charges if errors are identified.

For example, if a tenant is leasing 6,400sf of usable space versus 6,800sf that the landlord has estimated, which when increased by the common area factor, the resulting leased space is charged as 8,840sf versus 8,320sf. To demonstrate the resulting overcharges to the tenant see below:

Leased Space Audit

Measurements Estimated
Over Charge
Usable Space (SF) 8,840 8,320 520
Gross Lease Area (SF) 11,492 10,816 676
Rental Rate
($3/sf/month x 4 yrs w 3%/yr increases)
$2,196,453.19 $2,067,250.07 $129,203.12
(6 months rent)
$206,856.00 $194,688.00 $12,168.00
CAM Charges
($0.50/sf/month x4 yrs)
$344,7 60.00 $324,480.00 $20,280.00
Total Occupancy Costs
Entire Lease Term
$2,748,069.1 9 $2,586,418.07 $161,651.12

How can MNCs reduce corporate real estate costs within their global operations?

The solution involves working with an experienced global firm recognized for acute cultural and market knowledge. Click Here to learn more about API Global's Occupancy Cost Reduction Services, or Contact Us to discuss the specifics of your company's global real estate needs.