Need a short term lease? The deck is stacked against youApr 25, 2018
An office lease can be complicated. For an important project, you’ll probably need a broker, a building contractor, an architect, and a project manager. Here’s the problem: each one comes with his or her own set of financial incentives. It can be hard to know what those incentives are, but you’ll rely on their advice.
When you sign a lease you must predict how long you’ll need the space. Getting that right is tricky. Too short, and you might be forced to move before you’re ready. Too long, and you’re stuck with an unwanted lease obligation. Adding to those complications, you rarely get to pick the exact length you want. It must be negotiated.
If you need a long-term lease then your goals are consistent with everyone else’s. If, however, you want a short-term lease, cancellation rights, or other flexibility, then you have a problem. What’s in your best interest is no longer aligned with many of your advisors.
In an office lease, important elements are affected by its length. For example, the size of the construction buildout, the brokerage commissions, and the value of the landlord’s building. Here’s why:
- For the landlord, a long-term lease means a more stable income stream and fewer turnover costs. Lenders offer lower interest rates for buildings with stable income. Investors will pay more for buildings with stable income.
- For most tenants, a longer lease justifies a larger investment to customize their space. That means the contractor, architect, and project manager all get a bigger project.
- For brokers, their commissions are tied to the length of the lease. Not just for the landlord’s broker but also for your broker. Commissions might be based on a percentage of the total contract rent or the square footage and number of years. In either case, a longer lease means a bigger commission.
Some tenants ask, why is my broker getting a bigger commission for a longer lease? Who made that rule? Answer: landlords. In North America the tenant’s broker is typically paid by the landlord. Landlords prefer longer leases and reward brokers accordingly.
It’s different in many European markets. Tenants, not landlords, often compensate their brokers. For example, in the United Kindom the commission is typically based on a percentage of the first year’s rent only, which means the brokers are indifferent to lease length.
So what’s the solution if you need a short-term lease? How do you guard against bad advice that leads to bad decisions? The same way we’ve done since the Romans declared “caveat emptor.” You must be informed. Recognize that if you agree to a lease term that is longer than you need, there are plenty of benefits for everyone – except you.
Know the incentives of people from whom you take advice. Do not rely on their inherit goodness to overcome those incentives. More importantly, don’t attribute their behavior to a lack of ethics. Understand their motivations and filter their advice appropriately. How are you supposed to know their incentives? Here’s an idea – try asking.