By Caleb McDow, Associate Director
When I was young, my dad used to tell me, "A good deal is when both people walk away happy". His view was that if a deal has been struck, then it must have been acceptable to all parties involved. If this were not true, then there would be no deal. I suppose this may have been an oversimplified view, but it carries some important insight for the concept of value.
We hear people and companies talk a lot these days about value. Some people talk about investment value, some talk about intrinsic value, and some even talk about adding value. But no matter what type of value you consider, it's important to know that EVERYTHING has some level of value. This is important when considering a purchase or lease of commercial real estate. The specifics of the deal are not limited to the purchase price or lease rate, but rather encompass an infinite number of “value points” that are in consideration by the buyer and seller.
When it comes to negotiating a commercial contract or lease, these value points are vital. It's certainly not a new idea that tenants will want a lower lease rate or price and landlords will want a higher one. But there are many other aspects of a deal that can provide value. In the end, the total value points must be high enough for each party, so that they are both satisfied with the result.
I recently did a deal with a tenant who had never leased commercial space before. He was purchasing a business and moving it into a new location. Because his business was young, he did not want to commit to a multi-year lease. He wanted to limit the length of his commitment just in case his business did not succeed. He also wanted a lower lease rate to keep overhead under control and allow for a higher profit margin. Unfortunately, these two value drivers were in direct conflict with one another. The owner was willing to accept a shorter lease, but not in connection with a lower lease rate.
After some discussion with the tenant, I was able to determine that the shorter lease term carried the most value for this tenant. I convinced him that even if he had to pay a higher rate, it was a lower “value cost” than being locked into a long-term lease. In this case, the greatest number of value points was found in limiting uncertainty by keeping the lease term short.
It’s important to note that many value points are determined intrinsically. For example, some people find value in leasing space from someone they know personally – even if it is leased at a higher rate. Another example would be a tenant who values visibility at their location – even at a much higher cost. Therefore, when I have a tenant who is considering a commercial lease, I encourage them to rank their value points in order of importance. Then, they can think of trade-offs they can make. This is really just negotiation 101, but it helps to take different issues involved in the lease and determine their relative value points. This will help avoid situations where the parties get distracted by issues that are really not important to them.
Here are some examples of potential value point trade-offs:
- A tenant can agree to a longer lease term in exchange for a lower lease rate from the landlord
- A landlord can agree to a low initial lease rate in exchange for a faster escalation in later years from the tenant
- A landlord can give a greater number of months rent-free in exchange for a higher lease rate from the tenant
- A landlord can provide a higher tenant improvement allowance in exchange for a higher lease rate from the tenant
- A tenant can provide a higher security deposit in exchange for a shorter lease term
Some people repair their own cars and others drop them off at the dealership. Some pay for valet parking and others self-park. Some people order room service and others pack their lunch. In every situation, each individual’s value points will differ. We trade these value points back and forth every day - sometimes without even realizing it. In each and every case, we make a value judgment based on what is most important to us at the time, either for the immediate future or more long-term. In commercial real estate, these decisions involve greater time horizons and often, tens or even hundreds of thousands of dollars. But in the end, the exchange is the same: a deal that is acceptable for all parties involved.