Risk vs. Reward in a Shifting Market
When tenant and landlord negotiate to extend a lease, each party must manage a distinct risk/reward calculus against the backdrop of the market. But irrespective of market, a successful negotiation will always hinge, in part, on identification and exercise of leverage. Of course, this is easier when the market is skewed heavily in favor of one of the participants. To be sure, there’s a lot more to success than just maximizing leverage. Yet now, when the market has undergone a material shift, it’s a good time to ponder the risk/reward relationship.
Over the years I’ve seen some ugly miscalculations. Sometimes these failures are due to what I would characterize as “circumstances beyond the negotiator’s control”. We have to always remember negotiations are done by people. People have bosses, investors, lenders, partners and others who influence their bidding. Here, I’m writing about the failure caused by ignorance or hubris.
How do we avoid such failures? We must be curious, educated and disciplined. Among the key roles of a real estate advisor is to provide perspective and knowledge. Transactions must be understood in terms of their impact on both parties. Each party has options (most of the time). Know your own, yes, but also know theirs. What can they accomplish if they don’t make the transaction on your terms. This is how we come to understand the inflection point at which risk outpaces reward – the danger zone.
When market leverage shifts in a material way, the party whom has enjoyed outsized leverage is often ill-prepared to meet the demands of the new market reality. They’ve become lazy, having named their price for so long. They make mistakes, they miscalculate. This is the environment in which we find ourselves today in San Francisco. The extent to which people adapt quickly and embrace the market, such as it is, will be a deciding factor in separating the early winners from the losers. Sure, if you can afford to eat vacancy for long periods of time, you could simply do nothing (e.g., not lease space) and wait for a better day. But very few landlords are in a position to do so; and, even if they were, it’s unlikely to yield better results. Landlords who are well-advised, curious and knowledge seeking, will, more often than not, find ways to keep their tenants. In a market where available space is likely to remain high over the next few years, vacancy quickly shifts from opportunity to liability. For the tenant, it’s about knowing (and respecting) the point of indifference. Understanding when the negotiation has reached a place where the counter party is reasonably assured of the same or better outcome if you leave. Since you’ve likely dragged them there, kicking and screaming, understand that they may be looking for a reason to walk away. So while tenants will (mostly) enjoy more leverage over the coming years, this is, nonetheless, a time to manage risk and reward with care.