Easing tenants into new leases where sqft has gone up.

[Chris H.]

I recently had my office complex re measured and maped out to BOMA standards. Usable sqft when up by 1000sqft and rentable sqft went up by 9000 sqft. 50 of the 60 leases are up for renewal (negligence of the previous property manager). Rents are below market. Utilities were covered in the gross lease but utility expenses have went up by 15% yoy over the past few years. It's time to break utilities out of the gross lease and offer modified gross leases.

We are at 100% occupancy. I realize I will probably lose a few tenants more so if all these changes happen at once. I've only ever rented usable sqft, not covering any of the shared common areas. Is it common to use a flat price per sqft or are common areas generaly lower then usable? How would you guys handle this issue?

• SQFT will go up by 30%
• Rents need to go up by about 20% to market rents. (Rents havent been increased in 3 years.
• Tenants will have to start paying thier own utilities.   

My thought is keeping the sqft cost the same for the first year of the lease and having kickers plus CPI to get more in line with the market. The new rentable sqft alone will boost NOI greatly.

[Daniel Chang]

Yes you need to do market analysis and see who your competitors are as the other posts mention.  But putting that aside, let's assume that what you say is true (rents below market, etc.).

In general, it's going to be easier for the tenants to conceptualize a $ PSF increase based on market rather than rent increase due to having the space measured.  Increasing rent due to remeasurement will seem "sneaky", especially if they've occupied the same space for awhile.  Also, I noted you were in CA. I don't know if you use standard AIR leases, but note that in there is the following wording: "the Base Rent stated herein is NOT tied to square footage and is not subject to adjustment should the actual size be determined to be different". So this will matter if tenants are exercising options.

If you just bump their rental rate 50%+, I think you will lose more than "a few" tenants.  I think a lot will leave on principle alone.  Office users tend to be more mobile than industrial or retail counterparts.  

What I find foolish that a lot of landlords do, is to insist that market rent is $xx PSF and stick to it despite vacancies.   If you have 60 units, you can literally create your own market within your complex, and find your own supply/demand curve.  Since you are 100% leased, that tells me that the rent is probably too low.  This is what I personally would do (just my style, not necessarily what you should do) I would start with your long term, good credit or likeable tenants. Do just a modest increase, or even no increase at all, or just have them start paying utilities. Once you get a comfortable number under new leases, then take the next batch of tenants, who are less desirable, and be more aggressive about rent increases, and so on so forth.  You will find a certain amount of rental increase that tenants will start leaving.  Then you just have to weigh the expected revenue increase from rental increases vs expected loss from vacancies (temporary or not)

Best of luck.