The Limited Value of a Handshake
People aren’t really shaking hands any more. Literally. And the figurative handshake has also seen better days, especially in the context of real estate transactions. To be sure, most office lease transactions are too complex to memorialize with a handshake. However, there’s a more practical factor at play that makes trust and commitment difficult. Specifically, until there’s a deal, there’s no deal.
The devil is in the details. When it comes to office leasing, it’s generally true that “grey area” favors the landlord. In other words, when the details are lacking, the landlord wins. In a shifting market where the leverage dynamic is moving away from landlords (San Francisco now), some landlords will look for ways to lull their tenants into letting time pass without committing to much, if anything. There’s strategic benefit. First, if the occupier has a favorable renewal option, the landlord will want to get past the outside date by which it can be exercised. That’s one less lever for the tenant. This also frees the landlord from a contractual obligation to the tenant, allowing them to market the space to 3rd party tenants and (potentially) create competition. Second, the closer the tenant gets to its lease expiration, the harder it becomes to negotiate a new transaction outside the building. Lastly, landlords being eternal optimists, they may believe the market will recover if they wait long enough (and depending on the circumstances, it may).
In practice, what are some of the ways landlords can slow play a negotiation? One is to simply say it’s too early to negotiate. This is usually accompanied by an explanation that it would not be “fair” to peg rent now, so far in advance of the lease expiration (fair to whom?). Another is by providing agreement to terms that are not fully understood by the tenant, for example, when a landlord offers to “turnkey” the space, either with or without a cap on its total cost exposure. Fundamentally, there is ALWAYS a cap. Landlords know how much it costs to build space in their buildings. Most tenants don’t. Hence a proposed cap may seem like a lot of money, but in reality it may fall well short of the actual cost. And when there is no cap, what usually happens is the planning and pricing get slow played such that discrepancies in what the tenant wants and what the landlord is actually willing to provide with the turnkey are revealed too late for the tenant to exercise the leverage created by a possible relocation.
There is nothing sinister about strategic negotiations. Each party should expect as much from the other. What we must watch for is disingenuous communication that creates the impression of a deal; when, in fact, the details are lacking - - - regardless of whether accompanied by a friendly handshake.