Determining the Best Length Term in a Lease

Last Updated January 6, 2017

When relocating and negotiating a new lease, there are several long-term factors that must be considered, not the least of which is the length term of the lease. Office leases typically run anywhere from three years to 15 years, with smaller shops skewing toward the former and larger enterprises skewing toward the latter. Smaller or newer companies simply cannot guarantee their long-term financial status and opt for shorter leases, while larger companies that are more established may be able to take on the financial risk of a longer term lease.

There are several other factors that should be taken into consideration when determining the ideal length term of a lease. These include size requirements, economic and market conditions, and whether a company needs a specially tailored space or can use a generic facility.

Basing a Length Term on Size Requirements

One of the easiest ways to select a length term is to factor in the amount of space a company needs. Corporate headquarters that require hundreds of thousands of square feet will naturally correlate to a longer term commitment. After all, a company doesn’t want to relocate thousands of workers and reallocate hundreds of thousands of square feet every few years. Barring a contingency in which a space is tied to a short-term contract, larger space demands should typically match up with long term leases.

Long-term or Short-term During a Bull Market?

The intuitive reaction to this question is usually that in good economic conditions a company should have the confidence to enter into a long-term lease. Likewise, a bearish market might suggest caution, and companies in slower economic conditions may choose to enter into shorter term leases.

While this seems to make sense to most, flipping that paradigm might actually be the better solution. When economic conditions are bullish, the cost of real estate is usually on the higher end of its own cycle. Entering into a long-term lease during good economic conditions can mean that a company is locked into a very high lease rate over several years. In slow market conditions, the reverse is true. Companies signing short-term leases may miss out on great long-term rates.

When deciding on a lease’s length, pay attention to economic and real estate conditions, with an understanding that the counterintuitive approach may be more advantageous in the long run.

Basing a Lease on Company Performance

A start up with only venture capital to keep it afloat might not want to enter into a long-term lease. A well-established law firm, on the other hand, with multiple decades of repeat performance and a stable business plan for several years into the future does not need to be as hesitant to enter into a long term commitment. Assess your business plan realistically and base a decision on the most feasible outlook for your company over the next few years.

Tailored Fit or Generic Space

If a firm or company has highly specialized space requirements that can require costly leasehold improvements, entering into a short term lease does not make much financial sense. Every three or five years a new space will need new buildouts, significantly driving up overhead costs. In these types of scenarios, the wiser decision is typically to enter into a long term situation and amortize improvement costs over the span of several years.

Building Flexibility into a Lease

Negotiating lease termination or contraction options into a lease can give your company the flexibility it needs to deal with fluctuations in the market and in your business itself. Associated costs with these types of options can include penalty rent payments and the required payback of cost items such as tenant improvement allowances.

These “insurance” options, however, can save an enormous amount of money when a sudden or drastic relocation is required. Use these termination benchmarks to reevaluate your company’s space needs and determine whether exercising one of these “escape” clauses is necessary. These options are not the easiest to negotiate; in fact, many Landlords may dig in their heels against these options. Getting a termination or contraction option implemented into a lease will depend on current economic and market conditions. A good way to improve your negotiation position is to hire a tenant representative. Hiring a tenant representative is one of the best ways for your organization to protect its interests during negotiations. Reliable tenant representatives will determine a balanced approach to your business situation and real estate needs and be a critical component in minimizing costs and mitigating risk.

Coy Davidson

Senior Vice President at Colliers International, based in Houston, Texas.