The Benefits of Riders that Bring About Flexibility to Office Strategies
In Japan’s office market, a fixed-term building lease agreement (fixed-term lease) is becoming mainstream, and many Japanese companies that are used to an ordinary building lease agreement (ordinary lease) may suffer unexpected disadvantages when a fixed-term lease expires.
Fixed-term leases are not flexible
Manufacturer A moved into a building, and the landlord presented it with a fixed-term building lease agreement. Manufacturer A was enticed by the building’s rent, which was cheaper than the market price, and began renting it under a five-year lease. However, when the expiration of the lease agreement was around the corner, and Manufacturer A tried to negotiate a renewal of the agreement, the landlord presented it with a new condition: an increase in rent by more than 30%. Manufacturer A looked for office space to relocate to, but could not find anything good. The deadline for moving out fast approaching, it had no choice but to accept the increased rent, no matter how reluctant it was.
It is said that in the current office market, vacant rooms are scarce and more and more tenants are suffering from agreement renewals of this nature.
The common style of a lease agreement in Japan’s office market was once an ordinary lease, which, in principle, are automatically renewed unless there is reasonable cause for termination and the tenant gives notice of termination. However, in the office market these days, fixed-term leases are becoming mainstream, particularly for A-grade properties. A new fixed-term lease needs to be signed upon the expiration of the previous leases’s term, and requires both the landlord and tenant to negotiate on the conditions again. This is more advantageous to landlords, mainly because they can present new tenancy conditions based on the market situation and rent the place to other tenants if their conditions are not accepted. They can earn more from rent by attracting new tenants when the office market is booming, and if they consider the future rebuilding of an old building, it becomes easier to remove tenants. As more and more building owners use a fixed-term lease, many tenants are finding themselves faced with situations like the one experienced by Manufacturer A above, mostly because Japanese companies are so used to an ordinary lease that they do not foresee future disadvantages that a tenant under a fixed-term lease might suffer when they sign the lease.
Why foreign companies love riders
How do foreign companies based in countries where fixed-term leases are the norm handle a fixed-term lease? According to Yo Ushijima of JLL Japan, who is involved in tenant consulting and tenant representation services for foreign companies that conduct business in Japan, “Foreign companies hate it most when a lease has a fixed term and impedes their business’s flexibility. Therefore, they insist on adding riders to their lease agreement,” as a matter of course. A rider to a lease is a new condition added upon the agreement of both the landlord and tenant, and stipulates matters not included in the written contract, which is prepared in advance. From the tenant’s perspective, adding riders means adding terms and conditions that are advantageous to them through negotiation with the landlord. “Some specific riders that I’ve seen requested are early termination rights, floor expansion options, rent caps, and no competition,” explains Ushijima.
The followings are examples of major riders. Foreign companies are familiar with these riders, but some Japanese companies may not be.
- Early termination rights
This allows the tenant to give notice of termination before the expiration of the term of the lease. It enables the tenant to rethink their office space quickly according to the changes in the scale of their business.
- Floor expansion option
This gives the tenant some time to consider renting other vacant spaces in the same building before those spaces are offered to other prospective tenants, and provides an opportunity to increase floor space within the same building should the tenant’s business has rapidly grown.
- Rent cap
This sets an upper limit on the rent under a renewed fixed-term lease in advance, and makes it easier for the tenant to develop their business plan.
- No competition
Although the landlord has the final say in tenant screening, this clause allows the tenant to prevent its competitor companies from moving into the same building. “It’s not easy to set this clause in local cities where the number of office buildings is limited, but in Tokyo, tenants often ask their landlords to add it,” says Ushijima.
- Others: Exemption from responsibility to restore the premises to their original state, bank guarantee of security deposits, etc.
“Some Japanese companies don’t even know that these riders are an option, and often sign an agreement, unsuspecting of the future disadvantages that they may suffer under a fixed-term lease,” points out Ushijima.
In order to earn riders...
Lease agreements presented by landlords often appear, in principle, not to acknowledge tenants’ needs for flexibility. It can be difficult to earn riders, especially when the office market is a lender’s market. However, Ushijima points out, “There are chances for tenants to earn riders that are advantageous to them. It all depends on how they negotiate.” Each client has a different office strategy—tenant consulting services aim to earn riders that help achieve an office strategy that is in line with the each client’s business plan.
“It used to be that many Japanese companies were less focused on flexibility in a lease agreement, compared to foreign companies,” notes Ushijima. However, use of a fixed-term lease has become the norm in Japan today, and tenants need to learn to negotiate thoroughly with their landlords. Otherwise, they could end up encountering issues like those of Manufacturer A, whose story was introduced at the beginning of this article. The expectations placed on tenant representation services are likely to become higher than ever.