The best term for your office lease depends on many different factors including, but not limited to, the history of the company, likelihood of changes within the company, ability within the building or business park to adapt to the company’s changing needs, volatility in your industry, volatility in the economy at large and many other factors like neighboring tenants, property management, landlord concessions, scope of improvements required and more.
The first consideration when determining lease term is whether the property can accommodate future changes of the business. Is there enough availability or ‘roll’ of spaces to accommodate future growth? Is the management style on-site a good combination for your company’s needs? Another important consideration is whether the space requires significant work to improve it adequately. Furthermore, is there flexibility in the lease so you can adapt to positive or negative changes in your business?
Most landlords will seek five-year leases while others will agree to fewer years depending on the scope of work they must do in the space and the extent of other concessions that a tenant requires. If an extraordinary amount of improvements are required by the tenant, then the landlord may require north of six to 10 or more years on the term so that they may adequately amortize those costs. If very little work is necessary, like simple refurbishment, i.e. repainting and replacing the flooring, a landlord may agree to three years – or fewer. This really is case-by-case with some general benchmarks as cited above.
The best way for a tenant in today’s market to get the best of all worlds – extensive landlord concessions plus flexibility of term – is with full-terms and market-based early termination rights with reasonable penalties. For example, some landlords (and more importantly, their lenders) will consent to a five-year lease with a full build-out of the premises and full concession packages of free rental periods and other sweeteners like relocation/installation credits while granting a ‘kick-out’ after three years or so. The penalties involved in exercising this right could range from a single flat fee to a myriad of credits back to the landlord like unamortized build-out, agency and legal fees as well as a series of months of rent and repayment of unamortized rental abatements. The penalty formula could be crafted in different combinations, but the main result is that a tenant would get the benefits of a full term plus have the option to terminate the lease early – paying considerably less than it would cost to see out the entirety of the lease term. In many cases there will be a window of time in which one can exercise this right and then it lapses. In other cases it could begin after a certain date and continue throughout the balance of the lease. Be cautious upon renewal – because this right will likely apply to the initial term only – and may not apply to future renewal terms unless that is stated in the renewal agreement.
Given the uncertain economy, at present and what lies ahead, and the largely level (not robust yet not dead) commercial real estate market, there is no way to reliably determine what tomorrow will bring. Different markets are showing different signs of life these days. My best advice is that tenants should get advice and guidance from an expert that is looking out for tomorrow for and not just today. Also, landlords may say one thing at the signing of the lease, but make no mistake, the lease will govern. Also, have a great commercial real estate attorney on board. Your landlord may sell the property later and you will be dealing with someone entirely different, or the person that you deal with may have a short memory. Make sure that you secure as many rights as possible formally in that original lease. These days tenants must strike a balance between terms and flexibility. Get what you need now, while hedging for the future in a responsible way. Be optimistic, yet realistic.