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Filling a new building is a challenge that developers and Commercial Brokers often face. Some potential new tenants may wish to relocate to a building but cannot do so because of an existing lease commitment.
February 01, 2004 -- In this situation, it may be necessary for the new building's owner to consider a takeover of a remaining term of the prospective tenant's lease in order to fill a unit. A negotiation like this can fill space immediately at some small costs vs. incurring losses by having the space vacant for months.
A lease takeover can be a very effective way of making rentals possible that cannot be otherwise completed. However, they require careful consideration. A prospective tenant is unlikely to consider a transaction involving a takeover unless the owner of the new building legally assumes the tenant's original obligation. So the owner of the new building must judge in advance the amount of time that it will take to sublet the tenant's old space, the cost of improvements to meet a new tenant's requirements, and the market value of the space. If these are incorrectly figured, serious losses can result for the owner, particularly if he is committed to a long takeover period. The current lease must be examined carefully to make sure that it permits a sublet.
An example could be a potential tenant with a remaining lease term of five years, who is currently occupying 10,000 square feet, with rent at $10 per square foot. He cannot be considered a prime takeover candidate for 12,000 square feet at $10 per square foot for five years.
However, in another example, a tenant has just two years remaining on a 10,000 square foot lease at $7 per square foot. The rent on this lease is $70,000 a year for a total of $140,000. The new space will be for 20,000 square feet at $10 per square foot for a ten year lease, a total amount of $2 million. The prospective tenant's present $7 per-square-foot space can be sublet for $5 per square foot and should take three months to sublet. When advertising costs, brokerage commissions and possible tenant work are factored in, the value of the tenant's space may be only $3.50 per square foot, resulting in a takeover loss of $35,000 a year, or a total of $70,000.
The owner of the new building may be ready to take over the unexpired lease, knowing the loss potential. He can make two proposals to the tenant: (1) waive $70,000 of initial rent (approximately four month's rent) and ask the tenant to assume the burden of renting his present space, or (2) amortize the loss, plus interest, over the ten year term of the new lease.
The $70,000 loss amortized over 10 years at 9% interest works out to approximately $120,000 in losses. This is just $12,000 a year, or a rental charge for the new space not of $200,000 per year and $10 per square foot, but of $188,000 per year, or $9.40 per square foot--a total loss of only 60 cents per square foot to the landlord in order to lease the space. |
