Leasing: Should they stay or should they go?

William Low
Commercial broker, Metro Brokers – DTC

Whether you’re a landlord or property manager, lease renewals are an everyday part of life. Often, it’s a “no brainer” that you want to keep a tenant. But just as frequently the decision may not be so clear cut. Here are some of the issues and strategies a landlord should consider when looking to renew the lease of an existing tenant.

The most obvious question to consider is, “Does the tenant pay the rent on time and in full?” If the answer is yes, and if it’s likely that they will continue to do so into the future, then you can check “yes” in the first box. If the answer is “no” or “sometimes,” then you need to consider the situation a little further.

Is the tenant fulfilling the other obligations or conditions of the lease? Consider if there have been situations where you’ve had to notify the tenant of a potential breach and, if so, did the tenant resolved the issue in a timely manner. Further, consider if those breaches were significant, i.e., failing to maintain the property or provide the required insurance certificates, or ticky-tacky, like occasionally taking up an extra parking spot.

Next, consider if the tenant constantly complains or asks for services that are outside the lease terms – or are they pleasant, easy to deal with and a good neighbor to adjoining tenants.

Are they maintaining the premises in accordance with the lease or are they allowing it to deteriorate beyond the normal wear and tear? If you’re a long-term investor, then keeping tenants who let the maintenance slide will only cost you in the long run and the tenant may not be worth keeping.

If parking is an issue at the property, pay attention to see if the tenant uses more spaces than allotted. A problem with some industrial tenants is that they may park nonworking vehicles on site or have an inordinate number of service trucks that take away spaces from other users. In retail centers, certain users can be “parking hogs,” which typically hurts the sales of smaller in-line tenants.

Is this tenant producing a large amount of trash or recycling, and, if so, are they actually getting it into the designated dumpsters? This usually isn’t an issue with most office tenants, but it can be an issue with many retail tenants, specifically restaurants, that generate a significant amount of trash as well as cooking grease, which requires separate containers. (Having managed a number of retail projects, I am constantly amazed by the employees’ inability to actually get the trash into the dumpsters!) Tenants who habitually overload dumpsters or who just toss their bags in the general direction of a dumpster can be a real problem. The garbage is not only unsightly, but poor housekeeping attracts rodents or other pests, which results in the landlord incurring additional costs and inconvenience to clean up after them. Many industrial tenants also tend to generate large amounts of trash, depending on their use (think used cardboard boxes, packing materials, used parts, pallets, etc.).

Is the tenant’s use consistent with the overall property and your goals for that property going forward? Again, this may not be an issue for some property types. But it can be especially critical for owners of retail properties who are trying to manage the tenant mix in order to maximize sales per square foot and therefore rents. For industrial property owners and especially multitenant properties, you may be trying to reposition the asset away from certain types of users (i.e., automotive, manufacturing or other “dirty” uses).

In many instances you may have gone down the list and the tenant is “Grade A,” leaving no question that you want them to stay. Unfortunately, you’re as likely to have a number of tenants that aren’t quite so stellar. So what now? Well, the answer is “It depends.” It depends on several factors that are likely outside the owners control – mainly, market conditions.

Denver, like much of the country, is seeing increasing rents and property values. But most of us remember darker days when you couldn’t buy a tenant. In a soft market, you may not have the luxury of being quite so discriminating about your tenants as compared to our current market, where there often are more users than available spaces. Where are current lease rates? Are they rising, staying flat or are landlords making concessions to keep or attract tenants? Beyond today, can you reasonably expect to negotiate a higher rent or more favorable lease terms in the future, or not? Is the tenant asking for any concessions – either rent, tenant improvements or other lease terms as a condition of renewal? If so, quantify them. It’s relatively easy to analyze the costs of tenant improvements and determine the impact to your bottom line. Other concessions may be more difficult to quantify but equally important to you as a landlord. (Think: use restrictions, options to extend, etc.)

Has the tenant retained the use of his own broker and is the tenant trying to make you pay the broker’s fee? While it can be frustrating or all out galling to pay both sides of a broker fee for an existing tenant, in reality it’s just another cost that you need factor into the equation.

Often – and especially if negotiations have been prolonged or heated – it can be difficult to step back and consider the following:

• If this tenant walks away, how long will I have an empty space? A crystal ball would come in handy in these situations, but without one you need to realistically consider the time it’s going to take to re-tenant the space, including the time it will take to get through the permitting and construction of tenant improvements.

• When I do find a new tenant, what TIs will I end up having to pay for in order to make the space useable and/ or attractive? Further, will I be able to amortize those improvements over the term of the new lease? If not, what will I have to spend to remove them when that lease expires?

In addition to TIs, consider what you likely will have to spend on lease commissions for a new tenant. Chances are that you’ll end up paying a full commission and not just one side when dealing with a new tenant. If you have a good relationship with an existing tenant that you want to keep, you are dollars ahead to begin the lease renewal conversation well in advance of the termination date.

• Will a new tenant be as credit worthy as the one I’m losing? It could be possible that you end up leasing to someone who is consistently late on rent or who may end up going bankrupt halfway through a new lease. If that happens, consider what you will lose in unamortized TIs and commissions. Again, a crystal ball would be a handy accessory for property managers or landlords – unfortunately, there is no magic ball, so we’re left weighing and considering the risk of keeping the existing tenant or rolling the dice with a new one.

Again, for many tenants the question of whether to renew or not is a no brainer. But for others, the decision may not be so clear cut. In addition, the decision is influenced by market conditions outside the landlords control. At the end of the day, we do our best to consider the market, how well the tenant is fulfilling the obligations of the lease against the probability and costs of a replacement tenant. And then sometimes the tenant is just not worth keeping and you can hardly wait for them to be gone and become someone else’s problem.

Featured in CREJ’s January 2020 Property Management Quarterly

Edited by the Colorado Real Estate Journal staff.