Understanding Leverage in Lease Negotiations

Real Estate Report

February 13, 2019

Leverage. When it comes to negotiating a lease, leverage is one of the key differences between a 5,000-square-foot tenant and a 100,000-square-foot tenant. Landlord lease forms are generally the same regardless of the size of the future tenant. But, when it comes down to the landlord’s willingness to negotiate away from the form, leverage is a critical factor.

Let’s assume two tenants are negotiating for space in a 500,000-square-foot building; a 5,000-square-foot lease is for 1% of the building area and a 100,000-square-foot lease is for 20%. The tenant seeking to lease 1% of a building has little leverage while the tenant seeking to lease 20% has significantly more leverage. The 20% tenant has negotiating power and should demand and command certain landlord concessions. The 1% tenant should focus on negotiating a few key provisions.

The perceived leverage of both landlord and tenant will determine how the negotiations play out. The landlord will ultimately remind the larger tenant that while it rents 20% of the building, the building is owned by the landlord, not the tenant. Symmetry in the lease between landlord and tenant, therefore, will never be achieved by the tenant. Despite this, the tenant’s lawyer should do a thorough markup and redraft of the lease. The redraft should be comprehensive and include all of the key items the tenant wants, as well as typical tenant-favorable provisions that may not be present in a landlord form. A tenant does not typically get more protections and rights than what it asks for in the first redraft but it almost certainly will get less.

Square footage and leverage, of course, are relative. If the same tenant with leverage were to propose leasing 100,000 square feet in a 1 million-square-foot building, and thus be representing only 10% of the building, the tenant’s leverage and negotiating power shrinks. The tenant in this situation should stress to the landlord that, in absolute terms, a 100,000-square-foot lease is a large lease notwithstanding its percentage of the building and that the tenant has numerous options with landlords that would be happy to have it as a tenant.

That said, it is important that a tenant not overestimate its leverage and understand that typically its leverage diminishes as the parties move further away from the letter-of-intent stage and closer to the date the tenant needs to move into new space. Overestimating leverage can lead to costly and contentious negotiations. If the landlord perceives that the tenant has no leverage and few alternative options while the tenant perceives that it has significant leverage (which is not unusual in lease negotiations), the negotiations likely will go badly and the parties will waste time and money negotiating and possibly, ultimately, not reach a deal.

The miscalculation of leverage happens more often than it should. To avoid this outcome, when there is a question, the landlord should communicate with its broker and lawyer and attempt, as a team, to assess the leverage of both parties factoring in the market, lease rent, term, build-out value, and other relevant lease factors. Concurrently, the tenant should communicate with its broker and lawyer about its actual leverage and options. The landlord and tenant should then have a realistic discussion about the perceived leverage of the parties and, ideally, the first draft of the lease that the landlord sends will be more reflective of both parties’ leverage.

Being this blatant about the leverage of the parties sometimes works, sometimes it doesn’t—but there is no real downside to having an honest conversation on the topic.