Go Short

If you are a long time follower of NeuerSpace, or know me at all, you know I am a lifelong, die-hard New York Yankees fan. Over the Thanksgiving holiday weekend, news broke that former Yankees top pitching prospect Phil Hughes had agreed to a three-year deal with the Minnesota Twins for $24m.  This bothered me, not because I was upset that Hughes was leaving the Yankees, rather, it's my opinion that he was poorly advised by his agent. Hughes won four games in 2013 and lost 14.  His earned run average, one of the main measurements for any pitcher, increased almost a full run over 2012 and I don't think anyone would argue that his performance in 2013 was disappointing.  He's 27 years old and has past success, winning 18 games in 2010 and 16 in 2012.

So why, at the low-point of his career, would he commit to a three-year contract?

Let's say Hughes signed a one-year contract instead of three.  Then let's say he goes out and wins 12 games.  Would he be in line for the same four-year, $49m contract that the Twins gave to another pitcher, Ricky Nolasco?  Nolasco is four years older and his career high in wins is 15 and that was in 2008.  Last year, he won 13.  Even if Hughes won eight games, wouldn't his stock be higher?

So why did his agent advise him to sign a three-year deal?  Maybe he doesn't believe that he will bounce back.  Maybe Hughes wants the security of knowing that he will be paid $24m over the next three years and will likely never have to work again.  Timing the market is tough and we rarely know the mindset of players, especially when they say silly things like "It's not about the money."

In commercial real estate, when we advise our clients with respect to lease term, we do have the benefit of knowing their mindset.  Sometimes, our clients want to go long-term to maximize concessions and take advantage of a weak market.  Other times, they want to go short, similar to what I think Hughes should have done.

Signing a short-term lease maximizes flexibility.  Companies can adjust their headcount - as well as their location - using short-term deals.  Given the ever changing economy, some companies want to be in a position to take more space in good times and shed space when it's time to tighten the belt.

In a rising market, some companies want to go long-term to protect against future increases.  However, given the long-term lack of rent growth in New Jersey, you could argue that if rents are starting to increase, a short-term deal will buy a company time until rents come back down.

Of course, there are advantages to going long-term as well.  In 2009, we were in the final stages of renewing a lease for 115,000 in Portland on behalf of one of our clients.  The economy was terrible and we negotiated a rent that was an historic low for that particular building.  At the very end of the negotiations, we were able to stretch the deal from a five-year deal to a seven-year deal, locking in two additional years at record low rents, while also negotiating a termination option at the end of the fifth year to maintain some flexibility.

This more resembles the contract that CC Sabathia signed at the height of his value after the 2008 season, which also included an early termination option. He later used that termination option to add years and millions to his deal.

Timing the market is impossible.  You never know when it's hit bottom until it's on the way up.  However, in the case of Phil Hughes, he knew he was at the bottom of his value and still was willing to sign a three-year deal.  If I was his agent, I would have recommended a one-year deal.  Going short sometimes has long-term advantages.