Short-term leases a long-term trend for Southern Nevada

Scot Marker, Senior Vice President, Colliers International – Las Vegas

Friday, July 24, 2009 | 6 a.m.

Scot Marker

In every economic downturn, a silver lining usually appears that marks recovery, or at least promise for the future. While cash-heavy investors have not begun gobbling up widespread bargains and turning around the current economy — nor is the stimulus package working wonders with job creation — we are seeing some bright spots that provide hope for economic rebound. One example is short-term lease agreements, which have gained popularity in the current downturn and likely hold the key to offsetting rising commercial vacancy rates across Southern Nevada.

As is typical of tighter real estate markets, short-term leases were next to impossible to find in recent years, especially in prime locations. Landlords locked tenants into agreements with terms of five to 10 years on average, and they offered little room for tenants to negotiate lease concessions, such as free rent and allowance from the landlord to improve their space.

Ironically, these agreements weren’t favorable for landlords, either, since they were unable to renegotiate lease rate increases as property prices skyrocketed during the boom’s peak in 2006-07. This irony provides a lesson that economic uncertainty exists even when times are flush and should be provided for when making long-term plans.

With the equally uncertain (bad) economic climate, the short-term lease trend has spread on a national scale. The New York Times ran an article recently on Manhattan’s rising vacancies and what it meant for lease terms. The story cited brokers and landlords providing examples of the transactions they had seen, and an increasing number were substantially shorter lease terms. But the situation is actually to benefit both parties. The article quoted Charlie Malet, executive vice president of San Francisco-based Shorenstein.

“Landlords don’t want to tie up space for what they perceive to be a low rent,” he said. “And if the tenants are a little uncertain about the long-term business environment, they don’t want to lock themselves into a 10-year deal.”

This trend is taking hold in the Southern Nevada market. Today, as more properties come online and others come up for lease in the valley’s retail sector, both landlords and tenants are adjusting expectations. In general, we’re seeing leases with terms of three years or less and renewals between 12 and 18 months. Both parties are now looking to sign shorter-term leases, and it is equally in their favor.

For example, the current market has allowed for certain operators in the Las Vegas Valley, commonly referred to as “mom and pop” stores, to become an important part of the retail landscape. Short-term leases are primarily the best bet for an untried retail concept in the market, because it allows for a tenant to focus on operating the business — not worry about the burden of a long-term lease — during a tough economic climate. Further, if the business can succeed in tough times, chances are it will grow once the downturn corrects itself. Mom and pop tenants are seeing opportunities that vanished during the boom a couple years ago. This is truly a great chance to tenant good real estate in the market. The relationship that has developed between the landlord and tenant in this time easily could become long-term, if the business flourishes. If the outcome is positive, tenants will no doubt get a lease term extension or, quite possibly, good references, if they desire to expand. For landlords, a short-term lease allows for renegotiation at a higher rate once the market rebounds and the startup retailer has evolved into a seasoned operator.

While on the surface this new trend might seem a depressing sign for landlords — they can’t sign longer-term leases — in fact, it is positive. In a market of decreasing rents and increasing concessions, landlords aren’t tied to low-profit leases once the market rebounds. Landlords still can increase their occupancy factor and generate revenue, which allows for reducing their existing debt. In many instances, the landlord will give the space to the tenant in as-is condition, with no allowance. This is usually the case with a vacant restaurant space that was left behind by a failed operation. The new tenant will save time by leasing the space that is already built out and ready to open. It truly can be a win-win situation in some special situations.

Consistent with long-term leases, landlords and tenants in short-term leases must maintain realistic expectations. Landlords will ultimately lease to good business people who pay rent timely, offering products and services needed by consumers. Tenants are looking for a rentable space that is in operational condition to conduct a successful business. New leases, whether long- or short-term, need to be beneficial to both landlord and tenant.

The benefits of short-term leases notwithstanding, some landlords still are pursuing long-term contracts with enticing discounted lease rates. However, new retailers should be cautious when faced with such a decision. With vacancy rates escalating, it would be easy to assume that a 10-year lease seems to be a sound decision. But the landlord will be locked into a low market rate for the remainder of the lease term.

It is becoming increasingly common for landlords to move forward with a five-year lease at a discounted rate for the first three years of the lease term and then increase to a much higher rent on the fourth or fifth year of the lease term. However, there are some qualified operators out there who are looking to expand and are willing to be realistic in proposing a lease rate.

Flexibility is a great asset to have when planning for future fluctuations in the business climate — and we all know how volatile these could be. If you aren’t strategically bound to a location, minimize your risk. The current economic state could persist much longer than we might hope.