Choosing the Right Lease Term (Length) for Your Commercial Location - For Franchise Tenants
This is one of those subjects that cause many lightbulbs to go on in the minds of those tenants attending our leasing seminars. As we explain in our new book, Negotiating Commercial Leases & Renewals FOR DUMMIES, choosing an appropriate lease term may be unheard-of to you; perhaps this is because a five or 10-year lease term has become such a norm in commercial real estate leasing. It rarely occurs to even seasoned franchise tenants that there should be – and actually are – alternatives to the traditional five-year lease term (with a five-year renewal option).
Please don’t misinterpret what we have just written. A long-term Lease Agreement has both advantages and disadvantages for both a franchise tenant and a landlord. For example, the more money you are investing into leasehold improvements, the longer your lease term should be. This will give you the security of knowing that you will be more likely to recoup your investment costs before your lease runs out. Longer lease terms are also desirable if the franchise tenant allowance is large; this allows a longer amortization period for the landlord to recoup his/her investments resulting in lower or nominally-added rent for the franchise tenant.
It’s not really the longer-term leases that we oppose at all, but the artificial five or 10-year lease term. Let us explain. Commercial tenants (especially retailers) prefer to open their business going into the peak season. From a sales and cash flow perspective, the optimum time for most shopping center retailers to open their doors is either September or October … the busy Christmas season ahead will bring in the most shoppers to the mall. Conversely, the worst time for a tenant’s Lease Agreement to expire (or come up for renewal is five years later – just prior to the same peak season. Rather than signing for a five-year (or 60-month) lease term, we typically recommend that our clients select their optimum lease term in months, rather than years.
The lease term goal for a franchise tenant should be to open for business going into his/her busy season and to end the term immediately after his/her peak season. This strategy will make sense to your accountant purely from a cash flow perspective. More importantly, this will benefit you from a negotiating perspective as well. When your five-year Lease Agreement in a shopping mall ends just prior to Christmas, the landlord has the advantage because space is in demand. However, if you had taken a 56-month or a 64-month month lease term, your Lease Agreement would be expiring when the space is less in demand, if at all. You now hold more of the negotiating cards!
You also need to consider that if you occupy a desirable location there may well be a competitor or another tenant trying to lease your space out from under you just prior to the holiday season. There is likely to be less chance of this happening (at least immediately) in a slower January through March season – depending on your individual type of business. The weather is another factor to consider. If winter is cold and snowy where you operate your business, you may wish to consider a lease term that expires in the warmer months when it will be easier (and more preferable) to move. When you plan to retire, sell or wind down your business is yet another issue.
If you are locating your business next to a major anchor store (such as a grocery store), ask how much of that anchor tenant’s lease term remains. If the anchor has only 37 months left on their term, then you may want not to exceed 37 months yourself in case the anchor does not renew. Alternatively, you could sign a longer lease term with the right to terminate – should the anchor store move. One franchisee once told us that he was strategically setting up shop beside a larger competitor in a building right next door so that he could benefit from the traffic flow created. This worked out well for about a year until the competitor’s Lease Agreement expired; the competitor did not renew, moved out and took the customers and traffic flow. Don’t make assumptions. Do your homework in situations such as these. Talk to other existing tenants in the property and gather whatever information you can.
Some retail/commercial tenants, in general, do not put enough time or energy into negotiating their lease renewal option when negotiating their primary lease term. We know this seems like a lot of trouble for something so far off into the future, but bury those feelings and set in place several renewal option periods stating the renewal period as up to three to five years. The words “up to” are key as you may not want a full five-year renewal option … you may prefer to stay only six more months while you are waiting for construction to be completed on the newer building down the street.
Franchise tenants should also make sure that their selected lease term matches their franchise term to avoid issues with the lease running out too soon. This happens when the start date of the franchise agreement is prior to the start date of the lease agreement – when the franchise business actually opens. Consider these different scenarios when negotiating your franchise agreement or renewal as it may be possible to have a franchise agreement length that better aligns with your leasing plans.
Our message here is simple. Don’t restrict yourself to what is offered for a lease term. Choose the lease term which is best for you and your business. By doing so, you will be further ahead. In leasing, commercial tenants don’t get what they deserve … they get what they negotiate.
For a copy of our free CD, Leasing Dos & Don’ts for Franchise Tenants, please e-mail your request to [email protected].
Dale Willerton and Jeff Grandfield - The Lease Coach are Commercial Lease Consultants who work exclusively for tenants. Dale and Jeff are professional speakers and co-authors of Negotiating Commercial Leases & Renewals FOR DUMMIES (Wiley, 2013). Got a leasing question? Need help with your new lease or renewal? Call 1-800-738-9202, e-mail [email protected] or visit www.TheLeaseCoach.com.