Leasing Guide: What If I Outgrow My Space?
First of all, does anyone really know how much space their company will need in a few years? This is normal.
If you’re a startup or rapidly expanding business, the most logical fit is a short term lease, but since they are
few and far between, what alternatives do you have?
1. If you’re doubling or tripling every few months, or are just starting with one or two people without an existing track record, a business center or executive suite might be the right temporary fit. You pay a much higher rate per square foot, but you have the flexibility of signing for often as little as 3 or 6 months and can quickly and easily expand with the center which can serve as an incubator for your business. All furniture and phones are usually provided and set up can be relatively seamless. It might be worth paying a few extra bucks to get you through a short uncertainty period and save you a lot of trouble and commitment.
Business centers typically don’t look into your financial background at all and require low deposits (since you are signing a “service agreement” and not a lease, they don’t need to spend up to 6 months evicting you. If you default, they can just kick you out like someone that’s had too many drinks at the bar).
2. Sign a standard lease. This can often be as short as 3 years. There are three common exit strategies for this
A) Growing within the building/portfolio. If you are bursting at the seams after a year and the landlord has a larger space for you (in the building or in another one of his buildings), the landlord will usually extend the first opportunity for his existing tenants to rent the space before it’s on the market.
This makes sense for the landlord since you are already prequalified (you already were checked out thoroughly when you signed the lease and have been paying rent since), he saves on legal fees since you have already reviewed and negotiated his lease, he won’t lose any rent on the upcoming space, and he can show your smaller and usually more in-demand space before you move. Obviously, he’ll also have less space available.
It’s not unusual for tenants to start in a small space and move five or six times over a few years into a very large space in the same building.
The advantages for the tenant are they can exit their current lease, they don’t have to go through a qualification process, don’t have to endure a lease negotiation (they can keep or adjust the already agreed points), and the move will be much easier.
In order for this process to work the most smoothly, there are a few key things to pay attention to:
- Although you will usually be accommodated regardless since it makes sense for the landlord too, it’s a good idea to insist there is a clause in your original lease stating you will be able to relocate to larger space as it comes available. There will be a percentage attached to this (usually at least 30-50% larger) since a landlord is not going to want to move you from 2000 sf to 2200 sf, it’s just not worth the trouble. There’s no reason a landlord should have an issue with this. Don’t confuse this with “a first right of refusal”. This is problematic for landlords because they may rent a space they did not think a tenant was interested in and then get sued by the tenant because he didn’t offer it to them first or because they didn’t decline it in writing (the landlord could get sued even if the tenant didn’t actually want the space). Also, they can’t give more than one tenant “first right” so someone else may already have it.
- Make sure you are in a large enough building. Being able to move around is great if you are in a 40- story building with space coming available frequently, but it’s fairly useless if you have a full floor in an 8 story building.
- If you have a small space, going with a huge landlord might also be a bad idea. If you have 1000 sf and your landlord owns 10 skyscrapers, relocating you is not going to be their first priority.
B) Sublet or assign your lease. Finding a subtenant is not always a piece of cake, but if you are realistic with your expectations and have a nice space, and use a good broker, you will find someone. If the market has sunk since you have rented the space, you should realize that you will probably still be taking a monthly loss on the rent even when you find a subtenant. However, if the reason you are moving is because of growth, your business is doing well and this is a legitimate expense that is aiding growth (and you are probably making more money).
If the market shoots up, you should be able to turn a profit on your space and/or rent it very quickly. For example, if you rent your space for $40 psf and two years later rents have increased 50%, you are paying about $43 psf (after 3% escalations) and the building direct leases are going for $60 psf. It would be easy for you to rent your space for $47 or $50 psf.
Keep in mind that there are usually clauses in leases that ownership will share your profits from subletting (after taking into account expenses like commissions, repainting etc). The percentage will be spelled out in your lease and can be negotiated. Sometimes the lease will even read that ownership will get 100% of the profits, which you should obviously try to bring down. Predictably, landlords will not share the sunken costs if you find someone to pay less rent than you are paying.
Since they are in smaller supply, sublets can be desirable for other tenants seeking short-term or even furnished space (if you don’t need your furniture anymore). Both can be huge selling points.
C) Go out of business. If the reason you don’t need the space is because your business has failed, you can dissolve the entity on the lease, adhere to the stipulations of your
good guy clause (usually giving enough notice, leaving the space in good condition, and leaving on time), and can walk away smoothly.
3. Negotiate a buy-out or
cancellation clause in your initial lease. Not all landlords will be open to this, but some will if it is fair. A typically buyout amount is determined by holding the tenant responsible for the balance of the landlord’s unamortized costs, cannot be used until a certain point in the lease (or sometimes only at one point), and will require a notice period. Unamortized costs primarily consist of brokerage commissions and cost to build the space. If you’re anticipating growth, it can be a good idea to attempt to insert a buyout since you will still have the option of subletting or growing within the building, but having a more clearly defined exit strategy can be advantageous.
To summarize:
- If you’re growing extremely fast or starting really small, spend a few months in a business center.
- If you’re expanding and your landlord can accommodate you in a larger space, great!
- If you’re expanding and your landlord has no space, you can sublet or assign. You might lose a couple months of rent or eat a monthly cost, but remember your business is expanding (good problem to have) and you are probably significantly more profitable and can afford this cost associated with growing your business.
- If you have a buyout clause and decide to exercise it, again, it’s the cost of doing business and the reason you are exercising it is that you are making more money.
- If your business has failed, you can disband the company and walk away from the lease.
Besides, wouldn’t it be more disruptive and costly for your company to sign a series of one-year leases, spend the last few months of each year frantically looking for space (since you are on a deadline), spend money and time moving, and lose time with rent overlapping? Why not pick out a building, location, and landlord that’s a good match for you and move around within their building without losing any rent overlaps, negotiating any new leases, and without having to even walk out of your lobby to look at new space.
It might make more sense to do the work once every 5 years and then focus on your actual job rather than trying to look for space every year. If your company is growing, you are probably very busy doing other things!
