Short-term office leases may never be as trendy as temporary pop-up restaurants on city street corners, but they increasingly are being considered by landlords and tenants in the context of office space.
Depending on the size of the space, a short-term office lease is one with a set term of less than three years, and, in some cases, even less than one month. Generally, a large office tenant will negotiate a lease with a relatively long term—in the neighborhood of 10 years—with various renewal options. Smaller spaces generally command shorter terms, but leases of fewer than three years are the exception.
That said, short-term leases offer advantages to both tenants and landlords. A tenant may be unsure of its future office space needs—or short on capital—and, therefore, may be hesitant to commit to a long-term lease. A landlord may find a short-term lease attractive as an alternative to allowing a hard-to-lease space sit vacant, not to mention an effective way to compete with often more flexible coworking space rivals. As both sides weigh the pros and cons of a short-term lease, here are some legal issues they should consider.
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Improvements: A short-term lease may have no work letter. The ideal short-term office lease is one in which the tenant is willing to take the premises as is or where required improvements are extremely minor and consistent with the building’s standard construction. For a short-term lease, a tenant cannot expect the landlord to contribute to significant build-out costs or for the landlord to approve significant atypical alterations to the premises. However, a landlord may be willing to spend a small amount of money to make the condition of the space usable, provided that the landlord believes the improvements will help lease the space again after the tenant’s short-term lease has expired.
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Operating Expenses: In most office leases, tenants pay a proportionate share of the operating expenses, and leases generally provide for these calculations to be made on an annual basis, prorated for partial months. Most office lease forms do not contemplate seasonal tenant occupancy. In negotiating the lease language, the parties should pay attention to how proportionate expenses are allocated. For instance, if a tenant leases the premises for three winter months, is the tenant paying 25 percent of the total annual heating bill or only the heat for those specific months? In addition, most office leases provide for annual operating expense reconciliations at the end of the fiscal year. This reconciliation structure may need to be revisited so that a short-term tenant’s expenses can be promptly closed out.
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Financial Accounting Standards Board (FASB) Rules: Since the relatively new FASB rules have taken effect, tenants now are generally required to show most leases as capital expenses on their financial statements, rather than accounting for leases as off-balance sheet operating expenses. A short-term lease benefits the tenant by reflecting lower overall rent and, therefore, lower capital expenses.
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Green Leasing: Longer terms are generally more consistent with green leasing standards. The turnover of leased space often involves the disposal of furniture, fixtures, equipment and construction materials, in addition to the reconnection of new equipment. Presumably, a longer-term tenant also has a greater interest in the efficiency and performance of the building’s mechanical systems. Ultimately, short-term and long-term tenants have different investments in building operations.
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Lease Form: A short-term lease needs to move through the negotiation phase quickly. Neither side wants to incur legal expenses for protracted lease negotiations. This type of transaction is primed for a "take it or leave it" lease form—as long as the landlord’s form is designed to address the specific needs of the short-term tenancy. Given that the lease term is so short, the tenant is likely ready to take immediate occupancy, so time lost in negotiation may shorten an already short term.
Retailers and restaurateurs no longer have a monopoly on short-term leases. Under the right circumstances, short-term office leases can be a win-win for both landlords and tenants.
ABOUT THE AUTHORS: Katherine M. Noonan is a member of the Real Estate Development and Complex Transactions Group at Ballard Spahr LLP in Washington, D.C. For more information, visit Ballard Spahr LLP.
This article was originally published in the September/October 2018 issue of BOMA Magazine.