Many issues come into play when determining how much space a business tenant needs when first taking possession of new office or retail space, but consideration must also be given to what the tenant's future needs might be.In general, there are three ways of addressing future needs -- an option to expand, a right of first refusal, or a right of first offer.An option to expand is available to a tenant in a strong tenant's market. It gives the tenant the exclusive right to take over other space, usually adjacent to the space that is leased initially. For the landlord, this means that space must remain vacant and available to the tenant while the option is in effect.While the general practice is to give the tenant a limited period of time in which to exercise the option, occasionally the option is delayed for some period of time, say five years, giving the landlord the ability to rent out the space to another tenant.Once that five-year period expires, the tenant has the right for some limited time to exercise the option.Whether the tenant pays anything to the landlord during the option period is subject to negotiation between the parties. For a strong tenant in a tenant's market, there might be no payments by the tenant. In a landlord's market, a tenant might be required to pay for the landlord's building operating costs applicable to the space, but no actual rent.Best for the landlordA right of first refusal gives a tenant the ability to take over adjacent space if a third-party tenant makes an offer to the landlord for the space. The tenant will have a limited period of time, perhaps 30 days, to match the terms of the third party tenant and then take over the space.This arrangement allows the landlord to actively market the space to third parties and forces the tenant to either match the terms offered by the new tenant or waive its right of first refusal.However this can create a "cloud" on the ability of the landlord to attract new tenants, because prospective tenants will not want to spend time putting a deal together that then has to be "shopped" to the existing tenant during some period of time that the new tenant could be out in the market looking for other space that is not subject to such a right.The landlord's position can be improved slightly by allowing just a letter of intent from a prospective tenant, rather than a fully negotiated lease, to trigger the notice to the current tenant. Or, the time period within which the current tenant can exercise its right can be shortened to 5-10 days rather than the typical 30 days.The right of first offer is generally the best arrangement for the landlord. When space becomes available, the landlord is obligated to make a good faith proposal to lease it to the tenant who holds the right, setting forth the terms under which the landlord proposes to offer to the market in general.The tenant then has a limited period of time within which to accept those terms from the landlord. If the tenant elects not to do so, the landlord is then free to bring the space to the market on the same terms.Unlike a right of first refusal, the landlord is no longer obligated to go back to the tenant to give the tenant a right to match the terms the landlord is able to reach with a third-party tenant. This is true even if the landlord is required to accept less favorable terms from a prospective tenant, provided that the offer to the current tenant was made in good faith.Another thing; When considering the future, it's good to remember there has been a considerable reduction in the office space allocation per employee over the past few years. Traditionally, the rule of thumb for corporate office space users was 250 rentable square feet for each employee. According to various sources, the average today is 176 square feet per employee as compared to 225 square feet in 2010, and may shrink to as little as 151 square feet per employee in 2017.Dan Scanlon, an adviser with Grubb & Ellis|Northern New England, Manchester, focuses on business tenant representation and investment sales. He can be reached at 603-206-9605 or firstname.lastname@example.org.
This article appears in the July 13 2012 issue of New Hampshire Business Review