Eston-analysis: Screenplay for re-negotiations

Market conditions

It has been one and a half years since the global financial and economic crisis reached Hungary and made an impact on every aspect of the economy. Although with a short delay, the aftermaths of the crisis shocked the real estate sector. New developments were suspended and both the private and the public sector kept back their intention to move.

The first signs of recovery showed up in the first half of the year but the impact of the crisis on financial markets and directly on companies’ financial situation did not pass away. Both consumer and business sectors were encouraged to make savings and cut costs in the past period making an attempt to reduce expenditure. Office market vacancy saw an unprecedented rise and the extreme oversupply resulted in a 10-30% decrease in rent fees.

Tenant activity dropped significantly in every sector, and the number and volume of contracts for new areas decreased sharply. In Q1 2010 almost half of office lease contracts were actually lease re-negotiations. Since the office rent fee is a relatively significant portion of company expenses, a paradox has occurred: some lessees see a business opportunity — generated by the crisis — in re-negotiations, while on the other hand, other companies were indeed forced to modify their actual lease conditions.

In the following section, we analyse the extent to which the two different situations require dissenting attitudes by lessors, lessees and advisors.

Tenants

For prosperous companies not having fundamental financial difficulties in paying their current lease fee, the low rental fees in the market offer good opportunities, to bargain over more favourable conditions during lease re-negotiations. Among ESTON’s 2009 tenant representation assignments, there was a client with a year 2012 move intention, who – recognising advantageous market opportunities – wished to fix the current low prices in the lease contract. Such companies typically tend to have a clear mid- and long-term vision, a stable background and they are committed to co-operate with the landlord. Some of the small and medium sized enterprises however are in such a dire financial situation that they can barely afford the increased lease fees now reaching 30-40% of their income. Besides their expenses having risen to extreme heights, the future of a company is often so uncertain that a long-term contract does not make business sense to them, even with discounted lease fees. In addition, those lessees having layoffs resulting in 20-50% downsizing may be forced to reconsider the conditions of their lease contract as well. One possible solution for them may be ‘sublease’, which is sub-letting the office space they do not need.

Lessor reactions

Lessors are also in a difficult position, as in the current competition for lessees it is a challenge to keep existing contracts, let alone achieve new ones. Given that long-term lease contracts are of value and importance for an office building, it would be logical to assume that lessors react positively in cases when a reliable, long-term lessee requests a lease fee reduction. These situations are usually easy to handle and the parties can easily reach a compromise.

The position of insolvent lessees is a great deal more complicated, and whether a company can continue its work or has to shut down might depend on the flexibility and understanding of the lessor. If a compromise cannot be reached, it might happen in rare cases that the lessee may move out of the office and thus break the lease contract.

ESTON consultants have found that lessors often react too late, only after the lessee already signed a new contract for another building, and they make hasty offers at a lower price. This situation could have been prevented early on with a little consideration and a slight fee reduction. If, however, the lessee does move out, the lessor faces high expenses and unforeseeable risks. Assuming that the office space will be out of use for a few months, the most important factor is the absence of the previously continuous income stream, and its additional consequences. The agency fee, paid partly by the lessor is another, although smaller problem. Moreover, the given office space rarely meets the needs of a new lessee, therefore the re-modelling costs shall also be paid by the lessor. This is likely to be higher than repainting the walls and changing the carpet, which could have been offered free of charge to the old lessee in return for his loyalty.

The role of the advisor

Advisors are able to work out market-based structures for lessees capable to make longer term (3-5 year) commitments. Through these arrangements, costs can be saved even without renewing the contract but within the framework of the existing agreement by offering discounts allocated all over the contract period.

When meeting a desperate lessee, the most important task of the advisor is to identify and prevent unrealistic offers from both parties, and also to propose constructive arrangements in order to achieve a ‘win-win’ solution.

In these delicate situations the most important goal is to keep the parties on good terms with each other, and to mediate between them, bringing the two positions closer to each other or, perhaps, to resolve the conflict of interest. By describing the potential losses resulting from the dissolution of the lease contract and affecting both parties, the advisor can eventually help the parties achieve an agreement.

Each negotiation is a psychological ‘game’ where it is the advisor who can utilise the appropriate communication skills, as he is aware of the objectives of both parties. That is why engaging an expert advisor can lead to an agreement and mutual benefits for both parties (such as lengthening the lease period, a temporary discount in fees, fixing the minimum and maximum of turnover rent).

For further information please contact our experts or visit our site at www.eston.hu and read the full issue of Property Watch under „Our publicationsâ€?.