Lease negotiation mistakes that harm SMEs

"Learn all you can from the mistakes of others. You won't have time to make them all yourself."  -  Alfred Sheinwold

Alfred Sheinwold was an American bridge player and an international team captain who would have refined his craft by observing the errors of others. One can confidently assume that commercial leasing was not in his thoughts when he made the statement quoted above. Nonetheless, his wisdom is very relevant regarding SME lease arrangements, for far too many tenants repeat the mistakes of others with binding commitments that harm the tenant organisation. Let's take a closer look.

Being stuck where you don't belong

"Nothing is as painful as staying stuck somewhere you don't belong!"  -  Mandy Hale

This statement summarises the impact on an SME of being bound to a leasing arrangement that does not fit their business requirements and risks. Over time, it becomes clear that any or all of the locations, premises, and commercial terms are out of sync with evolving requirements and risks, but unchanged lease obligations are increasingly painful. 

Our advisors are regularly approached by commercial tenants, particularly SMEs, seeking our help to minimise the pain of a leasing arrangement that is negatively impacting their organisation. The cause of the lessee's pain takes many forms, including retailers experiencing sales decline due to a location losing its appeal, unexpected capital costs required to adapt premises to the business requirement, unchanged lease obligations notwithstanding significantly impaired utility value (e.g. the pandemic lockdowns), inability to scale down the lease obligation when business requirements reduce, change in a tenant mix that harms one's business, no option to renew when locational goodwill is critical, rental escalations and market rent review provisions that work for the landlord but not the tenant, and a great many other causes. The impact is always painful, and the harm to the business can vary from limiting growth to insolvency when they cannot meet their lease obligations and their landlord calls on bank and personal guarantees. In reality, SMEs can mitigate the risk of being stuck where they don't belong.

Mitigating the risk of being stuck where you don't belong

"An ounce of prevention is worth a pound of cure."  -  Benjamin Franklin

There are many reasons why commercial tenants, particularly SMEs, get stuck where they don't belong. These include not starting with a clear picture of the essential elements of a lease arrangement that is optimally aligned with the business outlook and risks, not paying enough attention to risk mitigation in the lease negotiation process, not leaving enough time to build leverage, a lack of tenant side leasing expertise, and accepting advice from conflicted advisors. Whatever the cause, being stuck is unwanted, and the business will experience pain due to a misfit between the evolving business requirements and risks and the commitment to a specific location, premises, and commercial terms. Mitigating the risk of being stuck where a tenant does not belong requires a preventative mindset before committing to a lease arrangement, for it is challenging to get pain relief when the ink is dry. Here are some critical guiderails for applying this mindset.

In the first instance, the SME owners or executives must take the time to identify what locations, premises types, and commercial terms are vital to their success in the future and that they do this work before they look for premises. Far too many commercial tenants start searching for space before giving adequate attention to defining what accommodation arrangements best support their business in the future. This error means the landing point that works for the company still needs to be clarified, which opens the gate for subjective evaluation of alternatives, which almost always leads to regret. An analogous example that most of us can relate to would be searching for a family home to buy or rent without clearly defining one's requirements relating to location (schools, transport, shops, etc), premises (age, structure, aspect, maintenance, etc) and commercial terms (value, growth, occupancy costs, etc). The inevitable outcome is unduly influenced by the decision-maker's emotional response to a particular home, which increases the likelihood of an irrevocable commitment to something sub-optimal, evidenced by negative surprises that disappoint and increase occupancy costs. These surprises may include locational constraints relating to schooling or transport, premises surprises relating to much needed works, or commercial disappointment as one discovers in hindsight that a better deal could have been negotiated. At LPC, we advise our clients to think ‘business before space’ rather than ‘space before the business,' thereby stressing the importance of upfront clarity of the intended landing point to mitigate the risk of sub-optimal commitment.

Defining the appropriate landing point is a good start but is insufficient for preventing a lease commitment that a tenant regrets. Once the search begins, risk mitigation requires the generation of multiple alternatives, informed evaluation of these alternatives, discovery of the hidden market realities, lease negotiating expertise, and due diligence (location, premises, lease terms) to reduce the risk of negative surprises. These foci work together to minimise the potential for emotional decision-making whilst building tenant leverage in the negotiation process and keeping the focus on the pre-defined landing point. At LPC, we represent office clients who may prefer staying in their current leased premises post-lease expiry, and we regularly find that our systematic search and evaluation process uncovers alternatives that are a better fit for the pre-defined landing point. The discipline of the generate and assess process reduces stakeholder bias and facilitates informed decision-making and lease commitments that are in the organisation's best interests.

Concluding comment

Lease commitments are irrevocable and can help or harm the tenant's business. When any location, premises, or commercial terms do not fit the evolving business requirements and risks, the pain of being stuck kicks in. Cure after lease execution is difficult to achieve. Prevention before lease execution is essential, requiring directional clarity and skilful lease negotiation. It is crucial to mitigate the risk of decision-making that's not fully informed and driven by stakeholder bias or emotion. As Howard Baker (American Senator) said, "The most difficult thing in any negotiation, almost, is making sure that you strip it of the emotion and deal with the facts".

Who is LPC, and how can we help futureproof your accommodation arrangements?

LPC is a conflict-free advisor to commercial tenants across Australia and New Zealand. We facilitate strategic review of accommodation strategy, represent occupiers to secure best-fit accommodation arrangements, provide a lease management service to multi-site occupiers, and oversee fit-out and relocation for clients. Contact us to help with your accommodation strategy review.