How Long of a Lease Should I Sign?

The lease term that your business commits to should depend on the business’ goals and financial abilities. The first thing to do is to create a detailed five to ten year plan and budget to determine how much space the company will need and can afford both on a short and long term basis. Moving can be a headache and can disrupt business. Plus it doesn’t send a good message to customers if your business is constantly moving. Plan for the future and make sure the space is big enough to grow with you for at least a few years. Will you eventually be hiring more employees or expanding your service offerings? Ask about the possibility of expansion within the same location. You may want to ask for renewal options to ensure your rent won’t double when the existing lease term expires.

Most commercial landlords will accept lease terms of 3, 5, or 10 years. The longer the term, the more negotiating room the tenant has. On the rare occasion that a landlord signs a one or two year lease, they will be much less likely to offer any concessions.

Pros and Cons of long term versus short term leases:

A shorter-term lease may have the same rent per square foot (or stated monthly rent) as a long-term lease. However, this may not include does not include concessions like free rent and additional expenses that affect the bottom line payment. Most landlords provide some free rent (also known as rent abatement) as part of a negotiated lease. The longer the term, the more free rent a tenant can get. Also landlords will provide more construction allowance for a longer-term lease. So if a tenant is a small, growing business, it may want to find space that is already built out so that it can avoid having to commit to a long-term lease to facilitate an expensive build-out.

Longer-term leases are a great solution the company with predicable growth and planning. Additionally, in the case of the business that has made a large investment in its space, like a data center or law firm, longer term leases not only provide funding for construction, but avoid costly renewal negotiations when the landlord knows a business cannot easily move.

A downside to a longer-term lease is the way rent increases over time. Most rents have annual stepped increases. These increases can be fixed or tied to a CPI. Most rents are fixed and will increase, at around 3% a year. So if you sign a ten-year lease, you can expect the ending rent to be 30% higher than the beginning rent. The problem is that the market rarely keeps pace with this level of increase. So an argument can be made that a tenant who has two five-year leases will typically pay less rent at the end of his second term than the tenant who signed one ten-year lease.

Another downside to longer lease terms is the way expenses are charged to the tenant for the operations of the building. Most leases are based on a full-service gross (FSG) rent. That rent provides a base year for expenses. In subsequent years, any increases in expenses in excess of the base year, are billed (passed through) to the tenant. Over a ten-year lease term, these pass-throughs can become expensive as they increase far in excess of the original base year. If a tenant signed a five-year lease and renews its lease in the sixth year, that tenant should receive a new base year. That new base year restarts the expense pass-throughs for the new five-year lease term, obviating the increases of the prior lease term.

 

Content is provided by SwiftLease leasing agents.

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