When leasing commercial space companies must decide on the length of 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. For example, retail landlords generally require minimum 5-year leases and during the early years of the Great Recession 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 What (you can expect in concessions as a result), Who (generally prefers which), and Why (tenants may choose one over another).
There are a number of reasons that tenants may prefer a 10-year lease. One is continuity of operations. If a tenant’s use requires customers or patients to visit their space they have an interest in those customers and patients knowing where they are located; fearing that they may lose some of those customers/patients if they were to change locations. Similarly, if a location is highly desirable a tenant may want to “lock it in” for as long as possible so that the landlord cannot lease the space to a competitor or other business. In the same vein, if tenants have the opportunity to lease space in a tenant’s market, categorized by high vacancies (high supply/low demand) which puts downward pressure on rental rates, they may want to “lock in” that rate in hopes of paying below market rates for the duration of the lease term. Finally, depending on the extent of the tenant’s build out needs/costs, they may need a longer lease term over which the costs of their improvements/allowance can be amortized.
Doctors and dentists almost exclusively sign 10-year leases (if purchasing is not an option). Retail users are also prime candidates for 10-year leases due to the importance that their location within both a submarket and retail project impact their success.
Ten year leases are long enough to amortize the costs of most build outs. Interestingly though, improvement allowances seem to be affected by the law of diminishing returns. If a 5-year lease gets a tenant a $50/sf improvement allowance a 10-year lease will not likely result in a $100/sf improvement allowance. There is a dollar per square foot amount, different for each landlord, market, etc. over which landlords are not willing to go. They want to know that a tenant has some “skin in the game” to reduce the risk of default. Landlords may provide other economic concessions such as free rent as an incentive for tenants to sign up for a 10-year lease term as opposed to cash.
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