By Star Hughes-Gorup
In metros across the U.S., the next Salesforce, Google, and Facebook are expanding their business operations and planning strategically and tactically for their growth trajectory. While the growth is certainly extremely exciting for these upstart, high-flying innovation firms, the process of forecasting and mapping out their future growth can pose one of the biggest challenges: their office space. Historically, the office space world has not catered to high-growth startup firms–as most leases are for a minimum of 3 years (most common is 5), and office space is generally not a very liquid item on a firm’s financial statement! Because of this, company executives grapple with the unpredictability of their development and the necessity of protecting and maximizing growth possibilities.
One of the most significant issues for leadership involves handling the size of their office footprint, and understanding the options available in the marketplace as the company grows. Too often executives are confounded by the office leasing environment, as their broker presents a 3 to 5-year lease for 10,000 feet of space, only then to face massive complications six months later when their growth buildup necessitates 20,000 square feet.
Many executives believe there are no alternatives to the 3 to 5-year lease scenario, and instead choose co-working spaces that provide month-to-month flexibility. While this presents a quick fix, it also carries a price tag that is 5-to-10 times higher than traditional space, proving that it pays to plan ahead!
Across the country, we receive countless questions from technology, software and digital media firms searching for answers and solutions to their high-growth dilemmas. The good news for these companies is that there are proven strategies that can alleviate the pressures of rapid expansion from a space and leasing perspective, and we are happy to provide a few helpful tips.
Utilize the Portfolio
One of the best solutions for high-growth organizations is to align with a large-scale landlord, which holds a considerable asset portfolio of office properties. As examples, in California, two such companies–The Irvine Company and Kilroy Realty Corporation–own millions of square feet of space, which tenants can leverage to their advantage. In this scenario, a tenant would enter a standard 3 to 5-year lease agreement for 10,000 square feet, and then when the need to expand arises, the company is able to grow inside the corporate portfolio.
Recently, a Hughes Marino software and digital media client utilized a corporate ecosystem of properties to grow from 7,000 square feet to 12,000 square feet and then again to 20,000 square feet in an Irvine Company building. This benefits both the tenant and the property owner, because they benefit from keeping a tenant who is now paying more rent as a result of their expansion. This strategy can be implemented across geographies, buildings and market opportunities. The key to implementing this strategy is working with a broker who understands the ownership and financial structures of these landlords and who can effectively negotiate on the tenant’s behalf, a strategy that our team at Hughes Marino utilizes on a regular basis.
Know Your Rights
One of the most effective and commonly adopted solutions is the Right-of-First-Refusal (ROFR) and Right-of-First Offer (ROFO). In these scenarios, a lease contract includes language, which conveys to the tenant the option to match the terms and conditions of additional leased space offered to a third-party. As an example, consider a tenant who is currently leasing 10,000 square feet of space in a building with 5,000 more square feet of adjacent space. If the property owner receives interest from a third-party to lease the 5,000 square feet of available space, they first must approach the existing tenant to determine if they would activate the ROFR provision and match the new third-party lease proposal.
The ROFO condition stipulates that a landlord must approach the tenant first, before offering to the marketplace, any space: adjacent, contiguous or in the building, which the current tenant occupies. The ROFO is not as powerful a tenant tool as the ROFR, however each has specific strategic value relative to expansion plans. In each case, the tenant is mitigating some market risk by purchasing short-term protection on future space.
Landlords typically aren’t proponents of the ROFO and ROFR because these solutions transfer the negotiating power from their hands to the tenant. A landlord would rather see a scenario where a tenant had to sublease their space, while concurrently paying rent on a new space. The tenant could be liable for financial costs on two properties. While dual-agency brokers are far more apt to protect the landlord’s interest than the tenants in a negotiation, a tenant-only representation firm will always have the best interests of the tenant at heart, ensuring the best possible outcome.
Understand the Phase-In Option
The strategy of rent phase-in allows a tenant to lock in their tomorrow, while controlling their cash flow today. As an example, a recent Hughes Marino digital marketing client utilized this approach to secure 20,000 square feet of space on the first day of the contract, while only paying for their initial needs of 10,000 square feet. Under the lease terms, the tenant secured the economies of scale in the design and flow of the full space, but paid rent on 10,000 square feet for the first 6 months and on 12,000 feet in months 7-12. Thereafter, the lease rate applied to the full 20,000 square feet. The phase-in is a great solution for tenants to manage their growth timeline.
Consider Short-Term Leases
While 75 percent of office leases are 3-5-year deals, short-term 1-year leases are available. Another Hughes Marino client, an app developer, has moved office spaces year-over-year to incrementally ratchet up from 3,000 to 7,000, 9,000 and 12,000 square feet. While these 1-year contracts tend to be pricier, they do offer flexibility for the tenant.
Each of these strategies must be tailored to the client’s unique situation, business blueprint and growth cycle in order to maximize the future success of the client and their growth. Critical to negotiating the right lease for high growth technology companies is working with a broker who has the market intelligence in the firm’s locale. Tenant improvement allowances, ROFO and ROFR disclosure timelines and the money partners and financial backing of a corporate real estate entity are just a few of the issues a broker must consider in a lease proposal to set any business up for success.
Star Hughes-Gorup is a senior vice president and director at Hughes Marino, an award-winning commercial real estate firm with offices in San Diego, Orange County, Los Angeles, San Francisco, Silicon Valley and Seattle. Star is a key member of Hughes Marino’s San Diego brokerage team, where she specializes in tenant representation and building purchases. Star also makes frequent media appearances to speak on business issues from a millennial perspective, and blogs about life as a woman in a male-dominated industry at starhughesgorup.com. Contact Star at 1-844-NO-CONFLICT, or email@example.com.