When negotiating commercial real estate leases many business owners or companies focus on shorter term leases as they have the idea that it will give them more flexibility and reduce their costs & risk. While this may be true in some cases there are also a lot of businesses that would benefit more by signing a longer term lease. There really is not right or wrong answer as it just depends on how long your company has been in business, how financially stable it is, how many employees you have now and in the future, and what your business needs will be within the next few years.
What is a long term commercial real estate lease?
First of all let's be clear what I mean by a long and short term commercial lease as everyone has their own definition. Long term leases are typically 3-5 years or longer. Short term leases are typically 3 years or less. A new business or startup may think that a 2 year lease is a long time, however to commercial property owners and/or their agents 2 years would be considered short term.
What are the benefits of signing a long term commercial lease?
- Lower rental rate – Longer lease means you have more leverage to negotiate a lower starting office space rental base rate and lower yearly increases. There is also the potential to freeze the rental rate for a period of time. If you are a month to month tenant or your lease term is less than 3 years then landlords will typically charge premium rent, especially in a strong market.
- Rent abatement – This means free rent, like when you get to occupy an office space and not have to pay rent. Depending on the market you are in you can sometimes negotiate to receive rent abatement to help offset any tenant improvements, moving expenses, or just to incentivize you to rent their space. The longer lease you sign the more rent abatement you could negotiate. Now keep in mind if you are in a very strong commercial real estate market which some may refer to as a landlords market don't expect to get much, if at all free rent.
- Tenant improvement allowance – The more lease term you have the more tenant improvement (TI) allowance you typically can negotiate. The longer lease gives more time for the landlord to recoup their initial investment since they give you the TI allowance in year 1. If you sign a shorter lease the landlord may not give an allowance and you will have to cover 100% of the cost or they will give very little.
- Relocating is expensive – Having a longer lease in place helps you avoid the time, money, and inconvenience of bouncing around every other year. The larger your company gets the more expensive and time consuming it is to relocate. It's easy to move a small boat however when your trying to move a tanker there is a lot more time, money, and risk involved. It's easy for a new business or startup to bounce around the first couple of years especially if they only have 1-10 employees. After that it is more complicated.
- Stability – 1-2 years goes by very quickly! A longer term lease means more stability for the company and for the landlord. If you signed a 3-5 year lease then you are protected for the duration and cannot be forced to move until your lease expires (unless you negotiated a renewal option). If you are a month to month tenant in a hot commercial real estate market and in a property that is 100% full then you are at risk as the landlord starts looking for longer term tenants to replace you. If another business comes along and is willing to sign a longer lease don't be surprised if the landlord forces you to relocate………..or makes you sign a longer lease.
- More leverage in negotiations – As mentioned above signing a longer lease gives you more leverage in negotiating concessions and gives landlords more time to recoup the cost of giving you those concessions. It also tells the landlord that you are confident in your business. If you are only focused on signing a 1 year lease it could give the Landlord the impression that you are not confident in your business. If you are a startup that is confident, however it makes sense to sign a shorter lease in the beginning, then you need to make sure you articulate that to the landlord. You need to sell the fact that the Landlord should take a gamble on you and let you sign a short term lease as you plan on being a big fish later on.
- Expansion – If you are a growing company then signing a longer lease will give you leverage in negotiating expansion options. Options such as right of first refusal (ROFR) or must takes can be negotiated. With a shorter lease landlords will typically not give expansion option concessions. For example if you rent warehouse space with 30,000 sf and you plan on growing in a year or so you can typically negotiate to get a ROFR on any adjacent space. That means if any other company wants that vacant space the landlord has to offer it to you first.
These advantages were not meant to mean that every company should sign a long term lease. However it's important to really understand where your business is now, and where it is headed. If you are a startup or just not that confident in the success of your business then you will have to work harder to find commercial spaces that are open to doing 1-2 year leases. At the end of the day it's important that you do what is best for the business and if that means doing a short term lease then so be it. However if your business is stable and you are confident in the future growth then you can receive some great benefits of committing to longer leases.