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LEASE AGREEMENT REFERENCE GUIDE 1400: THE CONTINUING CORPORATE ASSAULT ON OCCUPANCY COSTS $49.95


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Lease Strategies
1400

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This LARG looks at the continuing efforts of corporate America to chop occupancy costs payable for the property it leases. The first article reviews the options available to the company determined to cut its leased property portfolio, and the factors that influence how much the tenant must pay to get out of leases with substantial remaining terms.

The Lease Clause Critique contains extended excerpts from two pro-tenant lease termination devices—the option to terminate contained in the lease itself and the separate termination agreement negotiated after the lease has been executed.


Number of Single Spaced Pages: 12

 

Excerpt

The Continuing Corporate Assault on Occupancy Costs

 

Downsizing, Merging and Calculating Lease Buyouts

In case you’re wondering whether the cataclysm of corporate real estate downsizing is over—it isn’t, and it might not ever be. Consider a couple of examples from the mid nineties to appreciate the scope of this trend. At the beginning of 1996, PacBell announced it planned to cut its administrative office space by 28% over the next five years. That surgery would reduce the Baby Bell’s administrative space from 9.5 million square feet to 6.8 million square feet. PacBell apparently had recomputed the amount of office space needed for its average administrative employee, and slashed it from 322 square feet to 150 square feet. What was PacBell up to with such drastic action? Cutting occupancy costs—that’s what. The company had resolved to reduce them by 25%.

Despite all the downsizing that has already happened, corporate America remains intent on further reducing its occupancy costs for leased space. In many large companies, occupancy costs for corporate facilities are second only to payroll and benefit costs for employees. This means companies can first cut staff, then get rid of the real estate it used to occupy. The financial allure of this one-two punch against corporate overhead is almost too strong for the chief financial officers of this world to resist.

It’s also noteworthy that PacBell’s plan was voluntary. It wasn’t caused by a merger, acquisition or other external corporate event. It was motivated by a desire to get ready for the corporate war that’s already happening in the telecommunications industry.

Merger Deals

Mergers usually spawn similar drastic reductions of staff and leased space. Look at what happened when Manufacturers Hanover merged with Chemical Bank. The merger triggered a dramatic elimination of office space occupied by the two institutions prior to their marriage. Before the merger, each bank occupied about 4 million square feet of space, either leased or owned—approximately 8 million square feet in the aggregate. In 1995, at the end of a long term space consolidation effort following the merger, the bank occupied a total of 6.5 million square feet.

Terminating Existing Leases

Downsizing companies normally have only a few options when they make wholesale reductions in their portfolios of leased space. They can:

  • try to assign or sublease space which has good market appeal;
  • for leases with minimal remaining terms, vacate the space and continue to pay the rent until expiration;
  • for leases which contain early termination options in favor of the tenant, take a walk pursuant to the option, and pay the landlord any compensation required for exercise of the early out;
  • for leases with substantial remaining terms containing no termination rights for the tenant—by far the most common scenario—negotiate a termination agreement with the landlord, and the tenant better bring its checkbook.
  • Computing the Size of the Buyout
  • In negotiations for an early termination of an existing lease on a large facility, the tenant normally must pay the landlord "buyout cash" for the right to walk early. Several factors influence the amount of the buyout paid to the landlord. These include:
  • whether or not the tenant is the only tenant in the complex—often exclusive tenants must pay more buyout cash than they would have to pay to get out of leases in multi-tenant buildings;
  • whether the facility is suitable for another use—special use space (e.g., manufacturing) may be extremely difficult to remarket given the small universe of potential new users;
  • the length of the term remaining on the tenant’s lease—generally the longer the remaining term, the greater the size of the buyout;
  • the unamortized cost of improvements constructed by the landlord for the tenant’s premises;
  • the general state of the leasing market, and the likelihood that the facility can be leased to some other user in the relatively near term; and
  • legal and brokerage costs for the transaction.

(continued)


End of Excerpt