A look at longer lease terms and what they mean

As the commercial real estate market continues to rebound from the recession, there are many positive signs that 2015 will be a strong year. An example is the movement toward longer lease terms. As businesses become more confident in their revenue streams and growth projections, they are more comfortable adding three to five years to their lease term.

While longer lease terms generally are a good sign for the market, businesses and landlords should think strategically to ensure the lease term fits their needs.

When debating lease terms, tenants should look beyond what they need today and focus on how their businesses will evolve during the next three to five years. Among the key questions to consider are:

Do they plan to expand into new markets, add to their employee base and/or broaden their product line?

Will they need additional space in three years for more company vehicles or larger equipment?

Will they need to consolidate several locations into one?

By projecting out several years, a business owner can create a clear vision for growth, including projected revenue and expenses. This type of planning, when combined with a thorough review of the real estate market, can help narrow down the appropriate amount of space — and the right lease term.

A tenant that is planning to consolidate three offices into one larger one in two years, for example, might want a shorter term lease that could be extended if those plans are delayed. A tenant with steady growth plans and a desire to know their rental costs into the future, might want to lock in today’s rents with a longer term instead.

Moving can be an expensive proposition, so tenants should make sure they are taking enough space to handle growth in the near term. If growth is expected, they should look for buildings that have the flexibility for expansion. Contracts can be written with a “first right of refusal” on additional space, for example, to ensure that a tenant has the first say in taking over another tenant’s space in the same building.

By taking out a longer lease term, a tenant also can lock in today’s rental rates. As the market is now regaining its health, there is a shift away from the “tenant’s market,” where tenants could call all of the shots. Landlords are now seeing strong leasing activity and are able to find more balance with concessions and lease rates.

When looking at lease terms, a landlord has a different set of parameters. Building occupancy is always a primary goal, but landlords also need to look at long term goals for the building. This includes any planned maintenance or significant renovations that would impact tenant spaces.

Landlords also want to remain focused on bringing in high quality credit tenants. These types of tenants help a landlord stabilize a building and improve cash flow. As such, extending out a lease term for a good prospect makes sense.

Landlords should continue to focus on credit worthiness to ensure the tenant has a good growth plan and can sustain a longer term. A tenant’s years in business, industry sector, and bank references all should be examined carefully before agreeing to a longer term.

As the market continues to improve, there likely will be more focus on longer lease terms. By working together and understanding the tenants’ long term needs, both landlord and tenant can arrive at a lease term that will satisfy each party’s need for stability and growth.

• Dan Brown is president of Brown Commercial Group Inc., a privately held commercial real estate company based in Elk Grove Village.