There are two main reasons why landlords love long term leases, “turnover” and “rent escalations”. However, before we can properly discuss those reasons, we must first define “Long Term Lease” and “Short Term Lease”. For the sake of commercial real estate, long term leases are leases longer than a couple years. It is important to note that most landlords won’t even consider a lease less than three years. The majority of leases fall within the five to ten-year range. Short term leases, are leases less than three years and there are few landlords willing to accept them.
Reason One: Turnover
With the meaning for “Long Term Leases” established, we can discuss the first reason why landlords love long term. That reason is the high cost of contestant “turnover”. If tenants are constantly moving, landlords have to constantly be dealing with vacancies (lost profit), lease negotiations (legal fees), construction, and commissions (to procuring brokers). These expenses, associated with tenant turnover, take years to recoup. On long term leases, landlords can amortize the costs annually and maintain profit on the properties. This would not be possible in the same way on short term leases.
Reason Two: Rent Escalations
The second reason landlords absolutely love long term leases, is rent escalations. All leases come associated with annual rent escalations in the form or either a fixed rate or Consumer Price Index based scale. These rent increases compound annually and lead to much greater yields for landlords. For example, if the annual rent increase is 3% annually over 10 years and the lease starts at $50PSF by the end of the lease the tenant will be paying over $65PSF. As you can see, this is very attractive to landlords increasing both their income and the value of the building.
For these two reasons you can help understand the logic behind landlords wanting long-term leases. As a tenant, the market might seem skewed towards landlords, but understanding how the market works benefits tenants both in locating and negotiating properly for their spaces. In our next post, we will be discussing “What to Do If Your Business MUST Take a Short Term Lease”.
– David Goldberg, Managing Director