Choosing the Right Terms: How Long of a Commercial Real Estate Lease to Sign?

As with any agreement, there are a number of important factors to consider before entering into a commercial real estate lease. Whereas a residential lease typically lasts 12 months, the commercial real estate world expects anywhere between three and 15 years. While small businesses tend to be more cautious and lean toward the shorter terms (and larger companies investing in longer-term spaces), the answer for your business may not be so clear.

Between size requirements, market conditions, and business outlook, there are many things to consider before making a decision – not to mention the location itself.

Why Picking the Right Lease Length is Important

Ultimately, the ideal length of your lease is most dependent on three things: size, trajectory, and success of your company. Just as with any long term agreement, you shouldn’t dive right into an attractive offer if it’s going to hamstring you for years – even decades – to come.

Smaller companies without the promise of long-term growth and success shouldn’t agree to a lengthy lease agreement lest the worst happen and the business fails, leaving the owners liable for the remainder of the lease (short term lease agreements don’t often come with terms for subleasing). On the other hand, larger companies who choose short term lease agreements may not enjoy the increase in monthly expenses once the initial agreement lapses, as landlords may try and take advantage of the success of the company and capitalize on its success.

What’s the Average Lease Length for Different Sized Companies?

Simply put, smaller companies like startups and small businesses should tread carefully when presented with a longer-term lease agreement. Not only does that option lock you down for a lengthy, legally-binding financial commitment, it limits your options when it comes to time expand, move, or shut down entirely. Short term agreements, which can last anywhere between 1-3 years,  however, provide an out for companies in a volatile market or with uncertain future growth.

Medium-sized businesses and newer companies that have already changed locations once or twice before should have a more reasonable outlook when it comes to long term lease agreements. With an established business history and a clear path for future growth, signing a long-term commitment is an easier pill to swallow, but many landlords will allow for a medium term lease that lasts anywhere between 3-5 years. If your financials are solid, your projected growth is reasonable, and your market research shows a trend toward larger profits, there shouldn’t be an issue negotiating a medium-term lease agreement. While you’re committed to a single location for a long period of time, you’re also able to see predictable monthly rent costs for the foreseeable future.

Large companies with multiple locations shouldn’t have any problem signing a long term agreement (5-15+ years). Not only do you reap the benefits of seeing a consistent overhead cost over a decade (or more) of future operations, you’ll have significantly greater bargaining power with your landlord because they see you as a long-term financial investment and may therefore much more likely to provide complimentary amenities like increased build out allowances, extra parking spaces, and free months of rent throughout the life of the lease.

What are the Benefits and Downsides of Short-Term vs. Long-Term Lease Agreements?

Short Term Leases (1-5 years)

Pros:

Businesses that expect a great deal of growth within the next few years, a short-term lease agreement allows for the most amount of flexibility and growth, helping a company quickly pivot to a larger facility should they outgrow their new space.

A short term lease agreement allows business owners some breathing room should their market take a volatile turn. Restaurants, especially, can see great advantage in a shorter-term lease. Due to uncertain market conditions and ever-changing culinary trends, securing a short to medium-term lease agreement is paramount to financial flexibility.

Cons:

A significant downside to a short-term lease is the restrictions around specialized build outs and facility needs, as landlords will be much less likely to provide tenant improvement allowances for short-term occupants. Short term leases often garner higher prices, fewer perks like parking spaces, and included utilities like maintenance or upkeep. After all, landlords aren’t going to see the lease as a long-term financial win if there’s a strong possibility that they’ll be shopping the space around again in a few short years.

And there’s a possibility that you’ll see an extension option at the end of the lease with higher monthly rental costs. Landlords see that as a financial protection as a reward for the risk they incur by signing a short term lease, so be prepared to pay more at the tail end of your agreement – or find a new location entirely.

Long Term Leases (5-15 years)

Pros:

The longer you agree to occupy a commercial space, the more likely you’ll see greater flexibility and perks from a potential landlord. Because they’ll have a steady, reliable source of income locked down for the foreseeable future, a potential landlord may offer additional funding for customization, build out, and industry-specific equipment. You may also be able to negotiate for a few months of free rent, monthly discounts, additional parking spaces for customers and employees, or cosmetic construction enhancements like new paint or new interior windows.

With more accommodating lease terms, making long-term budget projections becomes easier and more consistent. Plus, should you need to expand, sublease, or make exclusivity clauses, you’ll have a more straightforward path through those negotiations with a longer-term lease agreement.

Cons:

Obviously, long-term leases lack the flexibility that come with short term agreements and keep you locked in for the foreseeable future. But with companies operating in volatile industries or in the startup world, where success isn’t guaranteed, a long term lease can be a significant financial commitment that could outlast your company entirely.

The prospect of a new office location is an exciting one, but it’s too important not to pay close attention to the details and plan with meticulous attention. Choosing the appropriate length of a lease agreement for your company’s needs and anticipated growth is challenging, yes – but with the right planning and expertise at your side during negotiations, the length of your lease agreement can work as a benefit rather than a hinderance or limitation.

John is the VP of Sales at OfficeSpace.com where he leads broker relations and sales. Prior to being VP of Sales, he was the Regional  Director for the company. John has over 25 years of experience working in the commercial real estate industry. Before OfficeSpace.com, John was a commercial real estate broker for the Norman Company in Seattle, WA.

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