When leasing commercial real estate you will find that most landlords prefer longer commercial leases. If you are an existing, financially sound company that has been in business for over 5 years signing a longer commercial lease is not a big deal. However if you are a new business or startup company predicting the success of your company beyond 2-3 years can be quite challenging. Below are a few reasons why landlords prefer longer commercial leases.
- They want stable predictable cash flow – In order to maximize their assets and satisfy investors and banks landlords want to have predictable cash flow. Having a bunch of tenants with 1-2 year leases does not guarantee a return on investment in the long run. Having tenants sign a minimum of 3-5 years will provide more security and predictable income for their asset.
- The need to recoup a lot of up front costs – In most commercial lease deals to persuade tenants to lease space at their building landlords have to spend a lot of money up front. The capital they typically invest upfront may be architectural costs, attorney fees, tenant improvements, and commercial leasing commissions. Depending on the scope of work completed they may not make any profit the first 1-2 years or longer which is why they would want a 5 year lease or longer to recoup their initial costs and make a profit so get an acceptable ROI.
- The market is hot – If the market you live in is strong, rents are at an all time high, and vacancy rates are low then landlords would want to lock in tenant at the higher rates. Markets are cyclical meaning rates won't always continue to go up. At least every 8-10 years the market goes up or down. If they can lock you in at the higher rates for 5-7 years or more then it protects their investment during the downturn.
- Retail space – If you are renting retail space then most landlords will want at least a 3-5 year lease. One is for the reasons above. The other reason is because of perception. If customers see tenants moving in and out every 1-2 years it makes the shopping center look like it's not successful. Having tenants at a shopping center not only gives the center a better image but also gives the other tenants more confidence in the success and encourages them to stay there longer. All the tenants attract customers and that helps the shopping center as a whole.
Now that you know why landlords prefer tenants to sign longer commercial real estate leases you have to decided what is best for your business. Don't force yourself to sign a longer lease than necessary especially if it does not make business sense. I know you may really like one particular building that requires a 5 year lease, however if you are unsure about the future of your business then you will be setting yourself up for failure by signing a long lease. If the landlord will not budge on the required lease term then find a building that will be more flexible.