Part 3 of 4

|

[IMGCAP(1)]

|

SAN FRANCISCO—Many markets on the West Coast—including the SanFrancisco Bay Area, Silicon Valley, Portland, and Seattle—are hometo a unique breed of start-up companies. Thesecompanies have strong venture funding, potentialfor high growth, and exciting exit strategies.That is according to Eric Turner, principal atCresa Portland. We recently spoke with Turnerabout the specifics of start-up requirements, along withJoe Brady and Peter Hamann, SVPsat Cresa San Jose in part three of our four-part tenant Q&Aseries. “While the future often looks bright for these companies,they may experience turbulence when they need more office space toaccommodate their growth,” Turner says.

|

This is especially true since these companies and their landlords can have conflicting interests and trouble meeting each other'sdemands, he adds. “Fortunately, forward-thinking companies andlandlords can overcome these challenges.”

|

GlobeSt.com: What do these start-ups all have incommon?

|

Eric Turner: They are typically lessthan three years old; desire “creative space” to support theircompany's culture; strive to find ways to attract and retainemployees and achieve high growth; and are targeting an exitstrategy within one to 10 years.

|

GlobeSt.com: What are some of the goals for earlystage companies?

|

Joe Brady: Goals for early-stagecompanies are to limit upfront financial exposure, limit leaselength, secure attractive space to recruit and retain top talent,and negotiate lease terms that align with business objectives.Aligning with a real estate advocate who understands these needscreates leverage in negotiating with prospectivelandlords.

|

[IMGCAP(2)]

|

GlobeSt.com: Can their creative space requirementsbe easily met? What about in markets where demand is high andinventory is limited?

|

Peter Hamann: Creative spacerequirements can be difficult to meet, especially in those caseswhere demand is high and inventory is limited. Convertingtraditional office space into creative space is also expensive. Forexample, to convert a traditional office space with droppedceilings and high walls into an open, collaborative environmentwith no dropped ceilings, exposed HVAC ducting, exposed brick &beam, and other high-end features can cost upwards of $70 persquare foot to $90 per square foot. Landlords asked to pay for thiswork typically require longer-term leases (five to 10 years) to payback their investment. In addition, landlords will look forstrong financial credit from the tenant, similar to a lendinginstitution, and will require cash, letters of credit, personal orcorporate guarantees, etc. to help mitigate their risk.

|

GlobeSt.com: What should a landlord keep in mindwhen evaluating these start-up tenants?

|

Turner: When evaluating a prospectivetenant and proposed lease, the credit and financial stability ofthe tenant is a major factor. Landlords will want to review thehistorical and future funding or revenues of the company, itsfinancial statements, and executive leadership. When evaluating acompany's ability to fulfill its lease obligations, not all tenantsare created equal.

|

GlobeSt.com: As a follow up, what should happen inthe early negotiations?

|

Turner: Early in negotiations for aproperty, start-up tenants should “frame” the context of theirfuture goals to best position the company in leasenegotiations. Since there is no standard way of securitizinga lease, partnering with a real estate advocate who can speak tothe company's leadership, culture, growth plans, and financialwherewithal, etc., allows start-up tenants to align their planswith a potential landlord to minimize upfront capital obligationsand lease length.

|

In this context, questions arise:

  • How can start-ups balance the necessity of creating attractivespace that reflects their brand against committing to a 5-10 yearlease or spending significant upfront capital?
  • What components drive the landlord's requirement for long-termleases?
  • What can be done to secure the right space yet remainflexible?

[IMGCAP(3)]

|

GlobeSt.com: What are some of the creative solutionsyou have found or seen lately?

|

Brady: Even in tight markets,companies can find creative space and short-term leases, especiallyif they are flexible. The best way to secure a short-term lease andfavorable economic terms is to minimize the landlord's capitalcontributions and/or provide landlords with long-term, marketableimprovements for their building. Accepting a space in “as is”condition and finding solutions to minimize tenant improvementsthrough furniture systems can reduce the landlord's capitalexposure. In the event that tenant improvements are needed, try tocreate a work environment that meets the needs of the company aswell as improves the long-term marketability of the space for thelandlord.

|

Another approach is to identify the sublease options within themarket. Often, a sublease can represent a discount in marketrent, shorter lease term, and built-in infrastructure that oftenincludes workstations, data cabling, and furniture. Tenants shouldask their advisor to identify all “on the market” and “off themarket” sublease opportunities. Larger corporations may notwant to actively market a sublease for internal reasons, and anexperienced advisor who tracks and speaks with tenants should beable to locate these options.

|

GlobeSt.com: What about the negotiations? Whatshould start-up tenants consider in terms of protecting theirinterests?

|

Hamann: All lease terms, includingtenant improvements, are negotiable.And if start-ups find asuitable space that doesn't require significant capitalcontributions, they're in a better position to negotiate otherterms like length of lease, rental rates, rent abatement,termination options, etc. It is especially important forearly-stage companies to protect their interests. They shouldconsider aligning with a non-biased real estate advocate who willnot be compromised in landlord negotiations. Also, partneringwith a firm that incorporates project managers to assist with spaceprogramming, test fits, and building due diligence will protectagainst unforeseen issues.

|

GlobeSt.com: What if Short-term Leasing Isn't anOption?

|

Hamann: Fortunately, other creativeoptions can be negotiated into a lease: Subleasing, for example isthe process of disposing all or a portion of a leased space toanother company while remaining primarily obligated to the lease.This can be an attractive option, particularly if the space wascreatively designed and highly marketable. Also, do your homeworkon

|

landlords. Do they own properties that could accommodate you?Some landlords are willing to enter into a new lease mid-term toaccommodate a growing company in a different space theycontrol.

|

GlobeSt.com: What are the types of lease optionsthese tenants should investigate?

|

Turner: As part of negotiations,tenants should weigh lease options to help mitigate future risk,including:

  • Option to Terminate. For a negotiated penalty, tenantscan terminate their lease obligations. This is valuable inthe reduction and absorption of space and can be important in thevaluation of a company through mergers & acquisitions.
  • Expansion Rights. Tenants have pre-defined size rights togrow somewhere in the building or buildings controlled by thelandlord.
  • First Right of Refusals and First Right of Offers need to beproperly evaluated.
  • Option to Renew. Tenants have the right to stay in thebuilding. During a renewal period, the landlord typically haslimited down time, limited capital expenditures, and diverts risk.Therefore, tenants should receive below Fair Market Valuerates.
  • Option to Contract. For a penalty, tenants can give backa predefined amount of space.

Key to the overall process is the strategic planning that shouldprecede the search for space. It's important to think throughpotential impacts to the company's headcount and be realistic aboutgrowth.

|

GlobeSt.com: Are there any other upfrontconsiderations we haven't already covered?

|

Brady: Other upfront considerationsinclude:

  • Headcount: What does potential growth look like in one, three,five years?
  • Timing: Typical commercial real estate transactions cantake 6-12 months (or more) to execute. In tight markets, thesooner you start the process, the sooner you can be opportunisticin the market.
  • Defined space requirements: For example, open and collaborativework environment vs. traditional private offices.
  • Costs of relocation, including moving or purchasing newfurniture, installation of data cabling and network equipment,costs of the physical move, etc.

GlobeSt.com: Any last minute advice on how start-ups can mitigate risks?

|

Hamann: Start-up companies canmitigate risks and maximize returns if they start planningupfront. If they conduct due diligence on the front end, theywill invariably save considerable time and money. Whatever themarket conditions, try to exercise your leverage, and make sure youare aligned with experienced and objective real estateadvisors.

|

Check back in the next day or so for part four of thisexclusive tenant Q&A series, where we talk about conflictingbusiness models and conflicts of interests in CRE.

|

Want to continue reading?
Become a Free ALM Digital Reader.

  • Unlimited access to GlobeSt and other free ALM publications
  • Access to 15 years of GlobeSt archives
  • Your choice of GlobeSt digital newsletters and over 70 others from popular sister publications
  • 1 free article* every 30 days across the ALM subscription network
  • Exclusive discounts on ALM events and publications
NOT FOR REPRINT

© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.

Natalie Dolce

Natalie Dolce, editor-in-chief of GlobeSt.com and GlobeSt. Real Estate Forum, is responsible for working with editorial staff, freelancers and senior management to help plan the overarching vision that encompasses GlobeSt.com, including short-term and long-term goals for the website, how content integrates through the company’s other product lines and the overall quality of content. Previously she served as national executive editor and editor of the West Coast region for GlobeSt.com and Real Estate Forum, and was responsible for coverage of news and information pertaining to that vital real estate region. Prior to moving out to the Southern California office, she was Northeast bureau chief, covering New York City for GlobeSt.com. Her background includes a stint at InStyle Magazine, and as managing editor with New York Press, an alternative weekly New York City paper. In her career, she has also covered a variety of beats for M magazine, Arthur Frommer's Budget Travel, FashionLedge.com, and Co-Ed magazine. Dolce has also freelanced for a number of publications, including MSNBC.com and Museums New York magazine.