How is Fair Market Value Achieved on Renewals?

Imagine your lease is coming up for renewal and the terms of the renewal are broad. The lease likely states, “The renewal term shall be “X” years at a rate equal to Fair Market Value (FMV) or “X” percent greater than the last year’s rate.” Some leases might add the phrase “the greater of.”

The landlord will likely send you a letter stating what they perceive is the FMV and give you 15 to 30 days to accept or reject the offer.

Rather than focus on the potential legal jargon that may be involved, let’s focus on two issues. First, what does FMV include? Second, how and who determines that?

What would the landlord offer to a new third-party tenant in order to attract them? That offer may simply be the new base rental rate. Often a landlord might, without you asking, add a month or two of free rent or offer to clean the carpet as a renewal incentive.

Are you leaving money on the table? Besides the base rent, those concessions might include several months of rent abatement, parking discounts, significant TI allowances, moving expenses and more, all of which hold value to both parties.

The landlord’s view of FMV typically focuses on base rent while ignoring other possible concessions. They might argue that you don’t even need any concessions since you are already occupying the space. Some landlords may provide a slightly discounted rate while others will include certain concessions in other forms. Landlords will argue that they must keep the rental rate up to reflect FMV for others who are looking at their building. However, in evaluating FMV, most brokers do not use renewals as comps because they can fluctuate so much.

How can a tenant evaluate FMV? The best way is to engage a tenant broker. Although approximately 75% of our clients renew their leases, we always take them to market and through the same process of market evaluation as if it was a new term or potential relocation. We look at all of the options, explore what other landlords are offering new tenants, and consider what the tenant’s present landlord is offering to new tenants.

But what if your landlord says that you can do all the research you want but that they will not pay brokers on renewals? Let’s take a closer look at that positon.

To be frank, that is a 1950’s position created to keep the field unbalanced and in the landlord’s favor. Back then there were no tenant brokers. Landlords basically dictated market without challenge. By stating they would not pay brokers on renewals, two things happened. First, in most cases, your broker may simply go away. No pay? No work. Therefore, secondly, it left the tenant to fend for themselves. That is like trying to rebuild an engine using a video from YouTube.

Some landlords may argue that they are giving you a discount by not paying that commission. The reality is that even if you get a small reduction in rent as incentive to renew, the Band of Value (BOV), the sum of all the costs of the transaction, may still be more than a third party tenant would receive for a new lease with the landlord pocketing the delta.

And finally, if the landlord fends off the broker, by California law, the question arises as to whether or not the landlord (or his agent) is acting as a dual agent, representing both sides. Under SB1171 the landlord must present to you, along with any offer to renew, a 2079 disclosure form letting you know he is acting as a dual agent. Are you comfortable having the landlord or his broker representing you in your renewal?

Be certain that any renewal factors in the form of concessions or other value offered must be the same as they would be to a third party. And also be sure you are independently represented. If your landlord refuses to include the value of those concessions or payment of a commission to your representative, there are numerous conclusions one might draw.