When leasing commercial space, companies must decide on the length of the lease term. This decision is influenced by a number of factors, including but not limited to, growth projections, continuity of operations, build out needs, economic conditions, etc. Market conditions, outside the tenant’s control can also have an impact. Retail landlords, for instance, generally require minimum 5-year leases. Another example was during the early years of the Great Recession when landlords were willing to agree to nearly any length of lease term (sometimes as short as 1 year) just to get their spaces leased.
In this series I will be discussing the most common/traditional lease terms: 3-year, 5-year, and 10-year, but will also touch on less conventional terms shorter than 3 years, between 5 and 10 years, and longer than 10 years. I will touch on the Who (generally prefers which), What (you can expect in concessions as a result), and Why (tenants may choose one over another).
Perhaps the most common reason tenants may prefer a 3-year lease is flexibility. Three years is a relatively short time in business. Tenants may want the ability to move to another building or submarket. In uncertain economic times, many businesses may not want to lock themselves into a “long” term obligation and be on the hook for rental payments if the business fails. Another reason may be time. If a tenant needs to lease space quickly for whatever reason, i.e. their current lease is expiring, and they did not give themselves enough time to thoroughly evaluate their options, negotiate the most advantageous terms, etc. they may want to minimize the amount of time they are in a less than optimal space. Three year leases are generally the shortest lease term that landlords will allow.
Many new businesses or start-ups find 3-year leases appealing. They are still testing out their concept and may not have tools, data, etc. to make accurate projections for growth, revenue, etc. They don’t want to bite off more than they can chew; making a 3-year lease an easily digestible lease term.
Landlords amortize the costs of tenant improvement allowances over the term of the lease and 3 years is simply not long enough for landlords to be able to offer much money and still offer competitive market rates. Concessions can range from paint and carpet (flooring) and some minor demo to nothing. This is another reason why 3-year options are a preferred choice of tenants that are in a hurry. The build out process requires architectural drawings, permits, construction, etc. which can take months. Paint and carpet do not require permits and can thus be done “over the weekend;” allowing tenants to move in quickly.
It’s always recommended to seek the advice and services of an experienced commercial real estate broker when leasing commercial space. For more more information on representation, please contact me at Ryan@RealMarkets.com