By Rick Pearson, Cresa Woodland Hills
As an advocate for Tenants for the past 25 years, I am constantly looking for ways to build flexibility into the lease term. Ideally, the ability to expand and contract as business needs change would be included in all of the leases I negotiate. For several reasons, that typically does not work for the landlord, especially when the landlord is investing money into tenant improvements. Most of the time, Tenants are resolved to committing to a fixed term.
“Five (5) years”, “Sixty (60) Months” has been the most common lease term commitment over the past 25 years that I have been in this business. A 5-year lease gives the landlord enough time to amortize the tenant improvements while still giving the tenant the ability to reevaluate its space needs every 5 years. All-in-all the 5-year term has been a good compromise and seemed to work for both parties.
For those of us in the business, we’ve been seeing a change for the past 2 years. For those of you who will be looking at relocating or to remodel your space, you will soon learn that “7 is the new 5”.
A combination of factors have led to this change:
- Generally, the commercial real estate market has improved in almost all submarkets and segments, giving landlords stronger negotiating power.
- In California, Title 24 standards have dramatically added to the cost of new TI construction and remodels.
- TI contractors and subcontractors are busier, so they are less aggressive to get jobs.
- Material costs continue to rise.
Where a typical TI cost used to be $45/sf, the same build out is now $65/sf. When the cost of doing a deal increases, Landlords need to be able to amortize these cost over a longer lease term. Unless something dramatic changes, I don’t see this trend changing. Seven (7) years may become a more common lease duration.
There will continue to be a number of ways to build flexibility into these longer lease terms that all brokers and business owners should consider:
- Carefully plan for space needs into the future.
- A termination right, where a portion of the TI cost is paid back as a penalty.
- Try to find space that needs fewer TI’s
- Capitalize some of the TI costs on your own.
Between these longer lease terms and higher rental rates, I’m a bit concerned that my clients are going to be paying “above market” rents in the last few years of their leases if the market turns. If that is the case, we may be looking at doing “blend and extend” negotiations in 5 years from now.
I’ll certainly be talking about that, when the time comes.