We live in changing times, and that means that the business world we know may not be so, at least in the world of New Jersey real estate. Here are some truths that are just aren’t so:
Myth #1- When business growth is weak, demand for space decreases.
Reality: Here in New Jersey we have been losing thousands of jobs in recent years as whole industries like Big Pharma have been leaving. For example, look at Merck who is selling its Whitehouse headquarters to head overseas, or Sanofi Aventis vacating 3 headquarters office towers in Bridgewater and eliminating thousands of jobs. Yet in the last 12 months, while we have not added many new jobs or businesses we are practically out of space in some markets and vacancy rates have decreased to the lowest levels in decades.
Myth #2- As rental rates increase, demand for space decreases.
Reality: Look at Metro Park New Jersey where rents have increased by more than $10 per square foot in the last 12 months, the biggest spike in decades and demand for space is stronger than ever.
Myth #3- In uncertain times it is smarter for a business to have a short term lease to maintain flexibility.
Reality- The reality however is that the majority of New Jersey companies today are relatively stable and that they have not needed to downsize or right size, and that by having a short term lease they are paying a huge premium in rent. How big? Folks will be paying an average of 10 to 20 percent in higher operating overhead for a 1 year lease than for a five year lease. Not to mention that in a five year lease the tenant has far more leverage to negotiate Landlord incentives, like free rent and office renovations.
Myth #4- If I sign a 5 year lease I will be “locked in” and have no flexibility.
Reality- The reality is that it is possible to negotiate flexibility into a five year lease term, such as a one-time cancellation option at the end of the 3rd year.
Myth #5- If I exercise a termination option it will cost me more in the long run as there is usually a penalty I must pay to exercise the option.
Reality- The reality is that it may NOT cost you more. This one takes a little explaining, so hang in with me now and it will be worth it.
Let’s look at the example of a 3 year lease versus a 5 year lease. Assuming that the initial build-out was a conservative $15 per square foot allowance contributed by the Landlord and amortized over the term of lease, let’s compare the two deals:
$15 per square foot ÷ 3 years = $5 per square foot per annum.
$15 per square foot ÷ 5 years = $3 per square foot per annum.
So, in the above example, the Landlord would probably want a $2 per square foot higher rent for the 3 year term than a 5 year term because of the amortization.
While it is true that there will most likely be a penalty associated with exercising a termination option, if the penalty negotiated were equal to the unamortized improvement costs (in this case the $2 per square foot) the five year lease with a penalty option would cost exactly the same as a three year lease.
In that case, why make the decision to pay the penalty NOW by paying the higher rent associated with a three year lease if you don’t know for certain you will need to use it?
The realities above show what you think you know often just isn’t so. We suggest you consult with your real estate advisor to assist you when structuring a lease. He can help you understand the many paths to success in changing times.