This One Mistake Is Costing Business Owners Millions

Whether you run a large corporation or a small business, you need to outsource to experts. But if you ever rent physical space — for a local office to a national franchise — that may be costing you.

Would you hire an attorney who also represents the opposing side? That’s essentially what many business owners do when they rent offices or other corporate building space.

How? They hire brokers to help them find a good deal, but many of those brokers also represent the building owners you might be leasing from. Playing both sides of the table like this is a blatant conflict of interest. The building owner wants to charge the highest rental rate possible, while you want to pay the lowest rate. In this scenario, your broker simply cannot secure a good deal for both of you.

This happened to a friend of mine who headed international banking at a Fortune 500 firm. His daughter started a yoga business, and her broker convinced her to lease studio space in his own building. Even a savvy businessman like my friend didn’t know to counsel her otherwise. Needless to say, the broker didn’t negotiate a good rental rate for her — because there were no real negotiations at all.

Mattress Firm is even considering bankruptcy as a result of this issue. The retail giant alleges that a scheme by company executives and its brokers cost millions in high lease rates and kickbacks.

This mistake can affect any business that rents property and you can’t afford to make it. Paying too much in rent can ruin a small retailer or cost a global company millions. Here’s what you should do instead.

1. Ask your broker the right questions.

You need to uncover any potential conflicts of interest. Ask if they directly or indirectly do any of the following in your market:

Represent landlords, private owners, real estate investments trusts, or other property-owning institutions.
Invest in buildings or own any outright.
Partner with organizations that own buildings.
Provide asset or property management services for buildings you’re considering.

To justify representing both sides, brokers will tout that they have inside information from landlords and tenants, and that this is critical to secure the best deals. But that isn’t true -- creating leverage and “working the market” will net a better result. So if the answer is yes to any of these questions and you haven’t chosen a broker, consider one without these conflicts, such as a firm that only represents corporate tenants.

Otherwise, read on for additional steps to take. Bear in mind that firms may receive additional compensation for completing projects quickly, so don’t let them rush you.

2. Request a property list.

Many broker firms promise to send tenants to their owner-clients’ buildings. Your broker should fully disclose any property ownership or interests prior to presenting their shortlist of buildings to consider.

Ask for a list of these properties in your market when looking for rental space for your business. Then compare it against those they recommend. If the firm has an interest in all or most of them, ask to see additional building options or seek another broker.

3. Compare operating expenses.

Once you’ve narrowed down your choices, ask your broker to request a three-year history of the operating expenses. Compare each building and look for trends. For example, if costs spiked at any time, find out why.

If your brokerage firm represents building ownership, they may receive higher fees if the tenant pays higher expenses. Thus, it’s not in their best interest to minimize these costs — which are ultimately passed on to you.

4. Research the property management.

Good management matters when you’re renting space for your business. If your broker is with the same firm as the property managers, they may gloss over concerns you should have. It’s up to you to ensure they openly address any issues and ask the right questions in the negotiation process.

Request a list of other businesses’ contact information for references. Ask open-ended questions such as “What would you like to see the building change?” or “What other building would you rent space in, and why?”

5. Review the lease terms carefully.

Once you choose a property, review the lease terms carefully. You are beholden to that document for your entire lease. Poor negotiations in the beginning can result in a plethora of issues and surprises for years to come.

Paying unnecessarily high rent can bankrupt a small business or cost a large one millions. So start by comparing the lease rate against the standard market rate. Then carefully consider:

The length of the lease: Longer-term leases guarantee future revenue for building owners, so push back if your broker encourages you to accept longer terms than you would like. You can also negotiate “early outs,” renewal and sublease rights, and expansion options.
The “common area factor”: This reflects the building’s design efficiency. You will pay for the square footage of the area you occupy as well as a portion of the common areas — typically 12-20% for office buildings.
Review and audit rights: Negotiate the right to request regular audits of operating expenses. These audits should be performed by third parties unaffiliated with building management.
Utilities: Negotiate after-hours costs for utilities like air conditioning — if your company only uses the space from 9 a.m. to 5 p.m., for example. Ensure building management reviews these costs for cost-saving innovations.
Staff fees: Landlords may “double dip” with administrative and management fees. You should only pay one fee and only for the prorated time employees devote to your building. This should generally be 3-5% of your gross base rent.
Upcharges: Landlords may place an upcharge on expenses such as repairs, which should not be allowed if you already pay administrative or management fees They will not always declare upcharges separately, so confirm that there are none. Upcharges should never be applied to expenses like taxes or utilities.

6. Clarify expense charges.

Operating expenses are billed to corporate tenants on a pro-rata basis. Establish a baseline assuming 90% occupancy so you aren’t stuck paying taxes on the whole building if it isn’t occupied.

Annual increases on controllable expenses should be limited to 3-5% or the Consumer Price Index, whichever is lower. All of this varies by market and the sophistication of your negotiator.

Pay attention to how expenses are classified as operating or capital expenses. Capital expenses are amortized, meaning the costs should be charged back to tenants over time. This protects you from paying for the entire cost of a large expense at the end of your lease term.

Some building owners will try to convince you that a capital expense is an operating expense so they can bill you all at once. The lease should clearly define who is responsible for specific expenses. It should also state that Generally Accepted Accounting Practices (GAAP) will be followed.

7. Secure your own auditor.

The landlord’s auditors may ignore accounting discrepancies that could result in a rebate for you. Hire a reputable lease and tax auditor who will act as your fiduciary, meaning they agree to responsibly represent your business's financial interests. Ensure they have a history of securing significant rebates for corporate tenants.

Business owners will continue to lose millions in real estate deals until they learn to take these precautions or the landscape changes. But it’s difficult to disrupt an industry that has become complacent about this issue — especially with so much money at stake.

Most brokers have no incentive to change the situation, so it’s up to corporate tenants to speak up for themselves. The solution starts with you.

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