Should I Stay Or Should I Go?

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As Leases Come Closer To Expiring, And Rent Rates Continue To Rise, There Are Many Factors To Be Considered When Deciding Whether To Renew Or Relocate.

By Ted Roth, CPA

DO YOU renew your office lease or relocate your operations when the lease expires? Every five to 10 years, depending on the length of the lease term, companies are faced with this decision on each of their leased facilities.

The answer is based upon a variety of factors, both internal and external.

Shifting Dynamics

During the past 10 years, negotiating leverage has shifted back and forth between landlords and tenants. The current conditions of the office leasing market and the dynamics of the past decade have put many tenants whose leases expire in the next few years in a difficult position.

In the early to mid-1990s, the oversupply of office space, coupled with weak demand, resulted in a sharp reduction in rental rates. Rental rates bottomed out in 1995 and 1996.

As the economy heated up in the latter half of the decade and companies implemented aggressive expansion plans, excess space was absorbed and demand for space exceeded the available supply. Between 1996 and 2000, rental rates increased by 50 to 100 percent in most markets. Markets catering to fast-growing technology companies experienced even greater rent appreciation.

The office leasing market reached its peak shortly after the meltdown of the NASDAQ in April 2000. As the overall economy cooled, technology companies that had fueled excessive demand from 1998 to 2000 began to fail and the real estate markets flattened. In spite of that softening, rents remain near historical highs.

Rental Rate Shock

Where does that leave companies today whose leases expire in the next few years? Since most office leases are five to 10 years in length, many leases that are scheduled to expire in the next few years were signed when the market was far softer and rental rates were relatively low. With few exceptions, those tenants will soon be subject to rental rates that are 50 to 100 percent higher than the rents under their current lease.

To Move, or Not to Move?

For most companies, the decision to move or stay involves myriad factors, some financial and some qualitative. The following is a list of issues that need to be considered.

• Rent - This is not just a comparison of rental rates. As a newly designed space might be more efficient, requiring less square footage to accommodate current needs, one should compare aggregate rent from one alternative to the next. The impact of parking charges, CAM (common area maintenance) passthroughs, and the availability of energy should also be considered.
• Work Environment - How well does the existing space meet current and future needs of the company? Does it need to be renovated? Do your people need to be in private offices or in workstations? Will a new work environment improve employee morale and productivity? How well does each space facilitate communication and collaboration? Will the space you choose have a positive or negative impact on recruiting and retention of talented employees? This last issue is at or near the top of many companies' decision matrix, given the high cost of replacing employees.
• Improvement Costs - What is the cost of renovating the spaces under consideration, including the existing space? Can the renovations be performed while you occupy the space, or do you need to move out temporarily?
  

New paint and carpeting will cost about $5 per square foot. Move a few walls (which typically affects electrical and air conditioning distribution) and your cost can easily grow to $15-$20 per square foot. A complete build-out of new space from scratch can cost $50-$75 per square foot, including soft costs such as architecture, permits, consultants, and supervision fees. Even with a tenant-improvement allowance from the landlord, the tenant's out-of-pocket costs can be significant. Remember, for tax purposes, permanent improvements are depreciated over 39 years no matter the terms of the lease.

• Furniture - Should you buy or lease new furniture, or keep what you have now? This question applies whether you move or stay. In either case, the cost of purchasing new furniture and workstations can run between $20 and $40 per square foot of the premises. The same furniture under a five-year lease would run between $5 and $10 per square foot per year.
• Wiring - Bandwidth requirements have increased substantially over the past five years. Most companies now minimally require Category 5e cabling for voice and data transmission. In some cases, second-generation space (previously occupied by another company) will have updated wiring installed. If you plan to place your staff in the same locations as the previous occupant, the wiring can be reused. If you need to install a network in your present location or in a new space, plan on spending between $3 and $4 per square foot.
• Telephone System - While most telephone systems are transportable, many companies choose to upgrade outdated telephone systems when they move. The decision should be based on cost as well as the functionality of your existing system. Expect to pay between $50,000 and $250,000, depending on capacity and features such as unified messaging, voice over IP, integration of voice and data, etc.
• Moving Expenses - Moving expenses include not only the cost of the mover, but also the cost of new stationery, business cards, and announcements. These costs are typically $1-$2 per square foot.
• The Headache Factor - Regardless of the benefits of moving to a new space, some companies just can't bear the thought of enduring the headache of moving. In reality, the right team can handle the move of a single-floor tenant or smaller over one weekend. Tenants occupying numerous floors might require two or more consecutive weekends to accomplish the task.
• Location - If the current building is in the wrong location, the decision to stay or move might be very simple. In any case, location is one of those factors that affect everyone in the organization. When evaluating alternative locations, most companies plot employee commute patterns. Companies are also advised to consider the labor pools that surround each building under consideration; proximity to clients and strategic partners; and seemingly unimportant issues that actually carry much weight, such as parking availability and proximity of restaurants.
  
  

Decision Time

The decision to renew a lease or relocate operations is one that impacts most aspects of an organization, from financial to operational, cultural, and logistical. The difference between the right decision and the wrong decision can be millions of dollars in rent, capital, and productivity. By following the proper steps, a company greatly increases its chances of selecting the best option and negotiating the most favorable terms possible.

Ted Roth, CPA, is a founding partner of RBZ, LLP. RBZ is a leading accounting and strategic business-consulting firm with offices in Los Angeles and the Southbay.

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