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Lomax: Why the lease term matters
Many business owners when looking to lease real estate for their business often wonder why the owner wants them to sign such long terms.
The norm is three to five years, but what exactly is the benefit of going longer term than that, or what could be the advantage of a short-term lease? There are plenty of options when it comes to the length of a lease, and the objective should be to sign a length that fits your business goals.
Longer Terms = Longer Amortization
Rarely will a commercial space be in move-in ready condition.
Spaces should be renovated to fit your business needs, and that can require anywhere from putting down new carpet and a fresh coat of paint to completely gutting the walls and interior and starting over from scratch. Whatever the requirement, these improvements, called Tenant Improvements (TI), cost the landlord money.
The tenant can come out of pocket for these expenses, but typically, the landlord typically rolls these improvements into the rental rate, which is a process called amortization. Much like purchasing and financing a vehicle, the landlord will eat these costs and then amortize the payments of these costs over the life of the lease term.
If your tenant improvements cost $100,000.00 and you sign a three-year lease, this would make the rental rate higher as the landlord has less time over the life of the lease to make these payments on the $100,000.00 up than if you were to sign a five-year lease. Keep in mind, the more renovation required to make the space work for you, typically the longer lease desired. This is not always the case: exceptions may be in new developments seeking tenants or in down markets.
Flexibility Costs Money
A short-term lease may be advantageous for your business or necessary in certain cases.
If your business operates on contracts and only has a two-year contract, it would not make sense to sign a three-year lease for space unless you were certain a renewed or new contract would come into play. If your business is expecting major downsize or relocation, a longer-term lease would not be useful. A start up typically looks for a shorter-term lease as they want to test the feasibility of their business.
The benefits of a shorter termed lease are that the Tenant has flexibility, but the drawback is that this flexibility usually comes at a cost. The rental rate for a short-term lease may be higher than the quoted rate, or the yearly rent escalator could be higher than typical, should the tenant renew. The Landlord also will not be excited about putting much, if any, tenant improvement money into a lease that is on a short term.
While there are many considerations in signing a commercial office lease, lease term is one of the most important. Quite frankly, moving is expensive and requires time and labor. Finding a suitable office property that fits your growth and financial model as well as vision for your company should be top priority before signing the dotted line for your new office home.
James Lomax is a Commercial Real Estate Broker with Colliers International in Huntsville, Alabama. He can be reached at 256.503.6088.