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Choosing the Right Lease Term (Length)
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This is one of those subjects that cause a lot of light bulbs to go on in the minds of tenants attending my seminars. Perhaps it’s because a five or ten year lease Term has become such a norm in commercial real estate leasing. It rarely occurs to even season tenants that there should be and actually are alternatives to the traditional five year lease Term (and five year renewal options). Don’t misinterpret what I’ve just said. A long-term Lease Agreement has advantages and disadvantages for both tenant and landlord. For example, the more money you are investing into leasehold improvements the longer your Term should be. This will give you the security of knowing you will recoup your investment before the lease runs out. Long leases are also desirable if the tenant allowance is large thereby allowing a longer amortization period for the landlord to recoup its investment resulting in low or nominal added rent for the tenant.
It is really not long-term leases that I oppose at all, but the artificial five or ten year Term. Let me explain – tenants (especially retailers) prefer to open their business going into the peak season. From a sales and cash flow perspective the optimum time for most shopping centre retailers to open their doors is September or October since the Christmas season will bring the most shoppers to the mall. Conversely, the worst time for a tenants Lease Agreement to expire (or come up for renewal) is five years later just prior to the same peak season. Therefore, rather than a five year (60 month) Term I recommend my clients select their optimum tease Term in months - not years.
The lease Term goal for a tenant should be to open for business going into their busy season and to end the Term immediately after the peak season - but prior to the slow season. This strategy will make sense to your accountant purely from a cash flow perspective but more importantly to you from a negotiating perspective too. When your five-year lease Agreement in a shopping centre comes up for renewal just before Christmas the landlord has the negotiating advantage. However, if you had taken a 64 month Term or a 56 month Term, for example, your Lease Agreement would be expiring when the space is in less demand. You also need to consider that if you occupy a desirable location and your Lease Agreement is expiring going into a peak season there may be a competitor or other tenant trying to lease your space out from under you just prior to the busy season, there is likely to be less demand for the space in a slower January through March season depending on your individual type of business.
For some tenants other points for considerations regarding your lease Term include the Yellow Pages directory (both the publication date and the deadline for booking space). If your business relies heavily or even moderately on Yellow Page advertising consider this when selecting the best lease length.
The weather is another factor to consider. If winter is cold and snowy where you operate your business you may wish to consider a lease Term that expires in the warmer months when it’s easier to move. When you plan to retire and sell or wind down the business is also a consideration.
If you are locating your business next to a major anchor such as a grocery store with only 37 months left on their lease Term you may want no more than a 37 month Term yourself in case they do not renew. Alternatively you could sign a longer lease Term with the right to terminate if the anchor store moves. One franchisee told me he was strategically setting up shop in a building right beside a larger competitor so he could benefit from the traffic they were creating. This worked fine for about a year until the competitor’s Lease Agreement expired and they moved away taking their customers and traffic flow with them. Don’t make assumptions - do your homework in situations like these. Talk to other tenants and gather whatever information you can.
Tenants often tell me they have trouble getting a one, two or three year lease deal. Depending on how the deal is structured the landlord may have no problem with your request but maybe totally unaware of it even if you made an Offer to Lease in writing.
When you’re considering the lease Term you should also negotiate for a generous fixturing period. This is the rent-free period you have to buildout your store or business before the Lease Agreement commences. Thirty days may be enough if there are only minor renovations, but 45 to 90 days will give you more breathing room. So often tenants underestimate how long it will take to get design plans approved, building permits and contractors on the job resulting in a rushed or late opening.
Tenants in general do not put enough time or energy into negotiating their lease renewal option when negotiating their primary Term. I know it seems like a lot of trouble for something so far off into the future, but bury those feelings and set in place several renewal option periods stating the renewal period as up to three or five years. The words “up to” are key since you may not want a full five year renewal option but instead only 6 more months while you wait for the new building down the street to be constructed so you can move in there.
I recognize that many tenants reading this article will currently be in a Lease Agreement. We can’t talk about lease Terms without touching on the Overholding Period. When a Lease Agreement expires, but you continue to occupy the premises month to month this is called the overholding period. Most leases state that a penalty will apply to the tenant with an automatic 50 to 100% rent Increase. One tenant who ignored this clause was being charged double rent for three months before I was hired to negotiate a resolution with the landlord. Check your existing lease for this clause and make sure you negotiate a modified overholding period penalty (10 to 20%) if you can’t make it go away entirely.
Month to month leases have both pros and cons. On one hand a month to month lease provides maximum flexibility for the tenant. On the other hand it provides little or no security. If you are looking for a month to month Term (or as an extension/renewal of your existing Lease Agreement) then you may be better advised to sign a one-year short Term Lease Agreement with the option to terminate with 30 to 90 days notice. This way the landlord can’t lease your space to someone else - but if necessary you can still get out, legally and ethically. For some of my clients, with major setup costs, who want and need long-term security I negotiate a primary three-year Term with five more three-year renewal options (18 years total). This lets the tenant legitimately depreciate their equipment and leasehold improvement costs over a shorter time period than a standard ten-year Term. Frequently we negotiate a set rental rate for the first few Terms. If the landlord is contributing significant tenant allowance dollars then the tenant will pre¬-exercise the first two or three renewal options thereby guaranteeing the landlord a longer Term deal.
Get creative and get the Term you want! |
Posted date : (2007-08-15) |
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