What considerations should be made when startups are leasing space?
Looking into leasing commercial real estate for a new venture and wondering what experience has taught you. Is it better to sign a short-term lease to make sure the business works, or if, in my case, there will be a significant investment in prepping the space, would be smarter to lock-in a longer term lease? Why don't more businesses buy real estate so their monthly rent expenditures instead go towards equity in their location?
In general, if you are planning significant investments or improvements to the space, it's always better to lock-in a longer term lease: at least 5-10 years. However, even with a long-term lease, most commercial leases will factor in a 3% escalation to the base rent per year, which is important to factor into your P&L.
Also, make sure you understand the breakdown of price per square foot when you are reviewing the lease terms; most commercial leases are either triple net (NNN) or full-service, and total lease price is calculated differently for each.
For example, in a NNN lease, the base rent may be $19 / square foot, which is what you are locking in for the 5-10 year term, but the NNN cost per square foot fluctuates yearly based on total cost of common area fees (CAMs) which is pro-rated based on your footprint (rentable square feet) and can range from $9-12 / square foot depending on the building and property management company.
This brings the total price per square foot to anywhere from $28 - 31 / square foot, with only the base rent remaining the same throughout the length of the lease term. In a NNN lease, base rent is negotiable, while CAMs are not. It's important to know what you can and cannot negotiate when discussing lease terms with your landlord. Usually, the base rent goes down as the length of lease goes up.
You have many options when negotiating a long-term lease. Depending on the value of real estate in the area in which you are leasing, it's always wise to research the market rate for commercial leases and negotiate at least $3-4 / sf below market.
If you are planning on doing improvements to the space, include Tenant Improvements (TIs) in the negotiation as well. In high-worth areas where market rate leases can run anywhere from $25 - 28 / square foot (base rent, minus CAMs), it's common to have the building owner pay for upwards of $15 / square foot in TIs.
Other important negotiation factors:
Right of first refusal clause for opportunity to expand to other spaces in the building if possible
Ensuring it is possible to for you to legally sublease if necessary
Renewal option at a 'fair market rate base' at the end of the lease term
Obviously, if you want to limit the liability on your balance sheet, there's always the possibility of purchasing property. However, unless you're wanting to become a real estate investor, it's likely better to lease at first - especially as a new venture.
Many new ventures choose to lease space at co-working spaces first, because it's typically short-term and is all-inclusive, so you don't have to worry about setting up internet, or getting a mailbox, or printing, etc.
The price per square foot cost is typically higher (usually $60-80 / sf), but since it includes all operating expenses, you can usually cancel out the cost by not needing to hire an office manager or spend time setting up internet, etc. Most co-working spaces also offer short-term leases (9-12 months).