What a ten-year lease really costs

Anika had a number in her head when she started looking for a new home for her design studio: twenty-two dollars. That was the asking rate on the listing for a 2,000-square-foot suite on the fourth floor of a mid-rise building, quoted per square foot, per year. Two thousand feet at $22 is $44,000 a year. Over a ten-year term, $440,000. She could plan around that.

Anika is a composite, built from the kinds of small tenants who walk into this conversation every week, but her arithmetic is the arithmetic almost everyone does first. It is also wrong by something close to half a million dollars. Not because anyone lied to her, but because the number on the listing describes one line of a lease that has a dozen lines. This is a walk through all of them, using illustrative figures you should replace with your own.

The number on the listing

Commercial space in Canada is usually quoted as base rent, sometimes called net or minimum rent, expressed per square foot per year. That figure is the landlord’s return on the space. It is not what you will pay each month, and it usually is not fixed for the whole term. A ten-year lease commonly includes steps: a set increase at year five, say, or smaller increases every year or two.

Then there is the square footage itself. Leases are typically measured in rentable area, which includes your share of the building’s common spaces such as lobbies, corridors and washrooms, on top of the usable area you actually occupy. The difference is often called the load factor or gross-up. Two suites with identical floor plans can carry different rentable areas depending on the building and the measurement standard the landlord uses. Ask which standard applies and ask for the usable figure as well, so you know what you are paying for.

In Anika’s deal, base rent is $22 a foot for years one to five and $24 for years six to ten. That alone moves the ten-year base rent from $440,000 to $460,000.

Additional rent, the other half

Most commercial leases are some form of net lease, which means that on top of base rent you pay a share of the building’s operating costs and property taxes. This is usually called additional rent, operating costs or TMI (taxes, maintenance and insurance), and it is charged monthly as an estimate, then reconciled after the landlord’s year-end. If the building spent more than estimated, you get a bill. If it spent less, you get a credit.

Additional rent is not small. In many office and retail buildings it can run to a large fraction of the base rent, and in some it exceeds it. More importantly, it moves. Property taxes are reassessed, insurance premiums change, and cleaning, security and utilities contracts are renegotiated. You carry that risk for the whole term.

For illustration, suppose Anika’s additional rent starts at $14 a foot and rises three per cent a year. That is $28,000 in year one, and roughly $321,000 across ten years. Her real rent before anything else is now closer to $766,000 than $440,000.

Building the space

Very few tenants move into a suite exactly as it stands. Anika needs a reception area, two meeting rooms, an open studio and a kitchenette, plus data cabling and new lighting. Her contractor’s budget comes in at $90 a square foot, or $180,000.

Landlords often contribute to that work through a tenant improvement allowance, sometimes called a TI allowance or leasehold improvement allowance. The amount depends on the market, the building, the length of the term and the tenant’s covenant strength. Longer terms usually justify larger allowances, which is part of why a ten-year deal can look attractive. In this example the landlord offers $30 a foot, or $60,000, which leaves Anika funding $120,000 herself.

Read the allowance clause carefully. Many are paid only after the work is finished and invoices are submitted, which means you finance the build in the meantime. Some can only be spent on fixed improvements, not furniture, cabling or moving costs. Some must be claimed within a deadline or they lapse.

The landlord also offers four months of free base rent at the start of the term. That is worth about $14,700 in base rent, though in most deals like this the tenant still pays additional rent during the free period. Check whether your free rent is net or gross; the difference matters.

“

The asking rate tells you what the landlord hopes to earn. It tells you almost nothing about what you will spend.

The ten-year arithmetic

Put it all together and the picture changes. The figures below are illustrative only, rounded, and exclude sales tax. GST or HST generally applies to commercial rent; a registrant can usually claim it back as an input tax credit, but you still have to fund it month to month until you do. An accountant can tell you how it works for your business.

Divide $926,000 by 2,000 feet and ten years and the effective cost is about $46 a square foot per year, more than double the $22 on the listing. That is the number Anika should compare against other options, including a shorter lease, a smaller suite or flexible space.

The table also leaves out cash that is tied up rather than spent. Landlords commonly ask for a deposit, often equal to one or more months of gross rent and sometimes far more for a new business. Some ask for a letter of credit instead. Either way, it is money you cannot use for a decade.

The costs that never show up on a spreadsheet

Some of the most expensive parts of a long lease are not line items at all. The first is the personal guarantee. Small companies and new businesses are often asked to have an owner personally guarantee the lease. If the business fails in year four, the remaining six years of rent may become the owner’s personal problem. Guarantees can sometimes be capped at a dollar amount or a number of months’ rent, or made to fall away after a period of good payment history, but only if you ask before signing.

The second is lost flexibility. A ten-year commitment assumes you know how much space you will need in 2036. If you grow, you may need expansion or first-refusal rights on neighbouring space. If you shrink, you will want the right to assign or sublet with the landlord’s consent not unreasonably withheld, and ideally an early termination right, even one that costs a fee. Each of these has value, and each is easier to win at the start than halfway through.

The third is the clauses that can move you. Some leases let the landlord relocate a tenant to other space in the building, or end the lease early for redevelopment. If a relocation clause stays in, it should at least require comparable space and the landlord paying your moving and fit-out costs.

How to bring the number down

None of this means a ten-year lease is a bad idea. For a business that knows where it is going, a long term buys stability, a bigger allowance and more free rent. It just has to be priced honestly. A few habits help.

Negotiate the whole package, not the rate. A landlord may hold firm on base rent to protect the building’s headline value but give more on free rent, allowance or a cap on controllable operating cost increases. Model every offer as a ten-year total, the way the table above does, so you can compare a $21 deal with a small allowance against a $23 deal with a large one.

Settle the end of the lease at the beginning. Agree in writing which improvements you will have to remove at expiry and which can stay. That one conversation can take the restoration line close to zero.

Consider a tenant-rep broker. In many Canadian markets the tenant’s broker is paid out of the landlord’s leasing commission, though arrangements vary and you should ask how yours is paid. A good one knows what comparable deals in the area have actually included, which is information a listing never shows.