Terms of Endearment: Selecting the Best Lease Length
By: Dale Willerton
Often when I speak at franchise shows and conventions a tenant will ask me, "What is the best lease length?" The term, or length, of your commercial lease is an important part of your franchise business plan and ensuing lease negotiations. However, most franchise tenants do not take enough time to consider that one day they will eventually want to sell the franchise. Alternatively, they may want to expand/downsize, relocate, or close and so do not give the term of the lease the attention and consideration it truly deserves.
The industry standard lease term for a franchise tenant can be five, seven, or 10 years (but not shorter). For many of the more expensive franchise systems a 10-year amortization period is normally required on the initial term to justify that initial capital investment cost. Another point of consideration is that the lease term should start or commence going into the tenant's busy season and expire going into the slow period. Therefore, a 64-month term or a 117-month term may help you achieve that goal. What you are trying to do is avoid having your lease renewal negotiations come up when space is in demand.
Lease renewal options represent part of the overall term of the lease agreement and therefore should be negotiated at this time as well. The renewal option term is defined as the period of time which follows the initial lease term. This longer term protects the tenant so that the landlord cannot either take the space back or offer it to another tenant. Renewal options can benefit the franchise tenant and, therefore, one to two five-year renewal option periods are common.
In the real world, 10-year franchise leases are attractive to both the landlords and the brokers who represent those landlords. The landlord is assured of a long-term tenant while the broker, who works for the landlord, earns a commission for the term of the lease agreement. The longer the term you sign for, the more commission a broker is likely to earn. Overall, this should give the tenant increased negotiating power since the landlord is gaining the security of a 10-year term and the landlord's broker is receiving up to twice the commission he/she would normally have expected from signing a five-year tenant.
Suppose you come to the end of your initial lease term and you do not have a new agreement, renewal, or extension agreement in place. You will enter into what is called the overholding/holding over period. In itself, the overholding period is not a problem; however, many lease agreements contain a clause that states the franchise tenant's rent will substantially increase during the overholding period. I have reviewed leases with built-in increases of up to 300 per cent for the overholding period. A 50 to 100 per cent increase is the industry standard. Why does the landlord charge so much? The landlord wants certainty. This is the landlord's way of preventing you from sitting back, stalling, or remaining uncommitted about signing a renewal or going month-to-month.
If you wish to sell your franchise business before your lease ends - for instance, during year four of a five-year term - the renewal option and terms will be critical to the purchaser. It is absolutely essential that the buyer be approved by the landlord and the option is transferrable to him/her (and not personal to you). Not all lease renewal option clauses will be transferrable so this must be stipulated in as part of the original lease agreement.
You should also know that the lease renewal term does not need to be made in five-year increments. A franchise tenant can renew his/her lease agreement for any length of time the landlord will agree to. Alternatively, a right of termination could be negotiated if you need flexibility in the term. A right of termination is a special clause in the lease agreement which gives the tenant the right to cancel the lease. This is a one-time event ...if things are not going well for you into a five-year lease renewal term, you can negotiate to leave earlier at 24 months.
For franchise tenants it's also important that your lease term mirror your franchise agreement term. Right now I'm working with one franchisee that has his franchise agreement expiring one year before his lease term expires. This means we have to put pressure on the landlord to renew the lease term earlier than expected.
Franchise tenants tell us that there are three key reasons why they turn to a lease consultant for their new lease and lease renewal negotiations: to free up their time, save money, and have peace of mind that an industry specialist is working for them.
Got a commercial leasing or purchasing question? Need help with your new lease or renewal? E-mail me at DaleWillerton@TheLeaseCoach.com or call 1-800-738-9202.
Dale Willerton is The Lease Coach - a Senior Commercial Lease Consultant and author of Negotiate Your Franchise Lease or Renewal. Willerton works exclusively for tenants all across the US and Canada and regularly speaks at major franchise shows and trade conventions. Visit www.TheLeaseCoach.com./ www.HelpULeaseFranchise.com.
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