Short versus long term leases – Which is the best option for you?

by R.P. Emery & Associates

When negotiating a lease, it’s unlikely you and your potential tenant will have the same priorities. But because a good quality lease depends on a harmonious relationship between you and your tenant, it’s in your best interests to compromise. This is particularly important during the negotiation of lease terms.

Short term versus long term – the pros and cons

One of the first decisions you’ll need to make is about the duration of the lease – will it be short or long term?

A long term lease is typically five years or longer. Offering stability and security, they’re favoured by landlords and investors looking for a high return on investment (ROI), and tenants eager for stability of location.

A short term lease is generally for a period of 5 years or less. Perfect for landlords in a high demand area and agile and flexible tenants, they’re a great lower risk option.

And if you can’t decide between the two, you can always consider including the option of an additional term/s – it might be just what you need to satisfy both parties.

But how do you decide which option is right for you? Here are some of the advantages and disadvantages of long and short term leases, from the landlord and tenant’s perspectives.

Long term leases – The landlord’s perspective

Advantages

Stability - Long term leases offer stability of income and a guaranteed ongoing tenancy.

CertaintyA long term lease allows you to calculate your ROI over the period of the lease. This pays off in the long run as commercial properties are valued and sold based on ROI or yield. This is particularly so if your premises are located in an area where supply outstrips demand. If there is a likelihood the premises will remain vacant for any length of time while a new tenant is found, a long lease will work in your favour.

Disadvantages

More complex negotiations – Commercial leases can be lengthy and complex and negotiating a long term lease that satisfies everyone can be challenging.

Rigidity – Terminating or exiting a long term lease is difficult. Landlords may only do so under pre-determined, specific circumstances. To avoid these problems, consider the situations under which you might want to exit the lease. You can pre-empt them to a degree by including appropriate exit provisions in your lease agreement. However, as with everything in life, you can’t predict, nor plan for all of life’s future events with certainty.

Short term leases – The landlord’s perspective

Advantages

Flexibility - Short term leases give you flexibility in your tenant selection. If your property is in a high demand area – i.e. where demand outstrips supply – you can have the pick of the crop. If the market continues to perform well, you’ll have the security of continuous occupation, along with the opportunity to increase your rent (and alter your lease terms and conditions) with subsequent leases.

Disadvantages

Lack of security – Under a short term lease, you may lack security of income and continuous occupation. This in turn may affect the value of your property and ROI.

Lack of stability – Under a short term lease, you’ll lack the stability that comes with a long term, reliable tenant.

Long term leases – The tenant’s perspective

Advantages

Stability - For tenants wanting to firmly establish themselves in a specific location, long term leases are ideal. Ensuring tenure for an extended period, they provide protection from having to move if the premises are sold or if renewal options aren’t offered.

Certainty - Long term leases allow for long term financial planning. Depending on the rent review terms of the lease, a long term lease allows you to calculate your rental expenses over the long term. Even if the rent review occurs under a market rent review, a long term lease still offers an opportunity for long term financial planning that’s not available under a short term lease.

Flexibility - Tenants may find landlords offering long term leases are more willing to compromise on other lease terms. This may include a rent free period, opportunities to improve or modify the space and exclusivity clauses. Sublease options may also be available, enabling you to cut your long term rental costs. Although these concessions aren’t closed to short term lessees, they may be more difficult to negotiate.

Disadvantages

More complex negotiations – Commercial leases can be lengthy and complex and negotiating a long term lease that satisfies everyone can be challenging.

Increased maintenance and repairs costs – If the property isn’t properly cared for during the term of the lease, maintenance and repair costs can be high.

Greater risk – A long term lease means paying rent over a longer period. For some businesses, this is a financial burden and risk they can’t afford.

Short term leases – The tenant’s perspective

Advantages

Flexibility - For tenants with an uncertain outlook, short term leases offer the ability to scale up or down, moving locations as finances dictate. They’re also a great option for short term or ‘pop up’ businesses wanting to test the market.

A bail out option - It’s estimated that one in three Australian businesses fail in their first year of operation. Another two out of four fail in the second year, and three out of four by the fifth year. A short term lease is a less significant financial risk and offers tenants an ‘out’ in the event of business failure.

Disadvantages

Moving costs – For tenants changing locations with each lease, relocation costs can be high.

Lack of security – Tenants operating under a short term lease may lack security of location and tenure. If the goodwill of your business is dependent on a secure and longer term location, a short term lease may not provide the security of location you need.

Lack of stability – Under a short term lease, tenants may struggle to attract a solid customer or client base, particularly if they’re frequently changing location.

Retail leases

Retail leases operate differently to commercial leases. Other than Queensland, all Australian state and territory retail leasing legislation states that retail leases are automatically for a 5 year term – including any option periods. If a retail lease term is less than 5 years, it’s automatically extended to bring the lease up to a 5 year term. If tenants want a lease term of less than 5 years, they must seek legal advice.

If you’re a potential retail tenant, it’s your solicitor’s responsibility to advise you that if you proceed with a short term lease, you may lose security of tenure and may not recoup your setting up or fitting out costs.

While negotiation should be based on your needs, flexibility is key

Although you and your potential tenant may not have the same needs when it comes to lease terms, it is possible to find a middle ground. In the event that you prefer a long term lease while your tenant prefers a short term lease – compromise. You can always use a combination of the initial term – say 3 years – and grant options of 2 years plus 2 more years (3+2+2).

A compromise like this should satisfy both parties. Your tenant receives a longer term option while satisfying their short term needs. You receive a guaranteed income for a set period, along with the possibility of a longer term tenancy and increased rent if and when the options are exercised. And ultimately, this may be the kind of flexibility you need to exercise to seal the deal.

Ian Macleod is the CEO of the legal publisher RP Emery and Associates. They provide cost effective legal contract kits for Individuals, SME’s and the legal fraternity.

 

 

 



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