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How Long Should the Term of Your Lease Be?

Todd Ortscheid - Monday, June 4, 2018

Todd Ortscheid here with GTL Real Estate. This week I'd like to talk about the length of your lease. In other words, whether it should be for a short period of time or for longer. These recommendations I'm going to give are universal, whether you're managing your property yourself, or whether you have a property management company managing the property for you. I recommend this for everybody, for all leases.

Our recommendation is that you want all leases to be one year in length. You don't want to do really short term leases, and you don't want to do longer term leases for a few different reasons. The primary reason for that is that all of the benefit of a longterm lease is really going to the tenant. They're getting you locked in. They're getting possession of the property for this guaranteed period of time, and you basically can't get rid of them as long as they keep paying the rent, even if circumstances change in your life.

Let's say you signed a three year lease on a property, and after two years you need to move back in. The only way for you to do that is to pay that tenant a sizable amount of money, give them two months notice, and pay them basically to leave the property early. Because they have possession, that also means if they refuse to leave, the only way you're going to get rid of them is to take them to court and force them out, and you're still going to have to pay that amount of money, and still give them that much notice even if you evict them in that case. The tenant, because they have possession of the property, they have the upper hand. 

On the other hand, let's say the tenant wants to break the lease early. Even if you have a five year lease term thinking you've locked this tenant in for a long period of time, maybe you even have automatic rent increases thinking you've thought ahead to account for all possibiliites, the tenant is still going to skip out and leave you hanging. And the reason for that is it's very difficult for you to chase them down, and hold them accountable for that. In fact, a judge is not going to award you the rest of the three remaining years of that five year lease. They're not going to award you that rent even if you take that tenant to court. They'll only award you for the period of time it was vacant. And that's if you can find the tenant to file a lawsuit against them anyway. 

In this situation with this long term lease, you're getting basically no benefit. The tenant is getting a whole lot of benefit, but you aren't, so right off the bat it doesn't make a whole lot of sense. But it goes beyond that. There's a few other reasons we want to look at that demonstrate why this is a bad deal for you as the landlord.

The first of those is fair market rents. Almost all the time fair market rents are increasing year to year. Now there are certain times in very local markets usually where rents are reducing, but that's pretty rare. Usually even during a recession rents aren't dropping, and that's because the population is not shrinking. The population is always growing, so people always need a place to live. Housing prices may drop because people are renting instead of buying, but sometimes you'll even watch rents go up during a recession. It's very rare to see fair market rents actually decline. What that means is if you're on a long term lease, you're missing out on those rent increases, even if you write into the lease automatic rent increases.

Let's say we did a three year lease today, and we built in three percent rent increases for the next three years. Well, what if the market gets really hot, and the average rent is going up ten percent a year? That's not unheard of. Right now in certain parts of Denver, rents are going up fifteen percent a year. If a landlord had signed a lease with a tenant for three, four, or five years with built in rent increases even of five percent, which would have been considered high several years ago, they're now missing out on all those rent increases that would have been very easy for them to get if they had only done one year leases and upped the rent every year. It's in your best interest to make sure that you're able to increase that rent using fair market rents every single year. And doing a long term lease isn't going to let you do that.

The other reason to consider only doing year leases is because the law is constantly changing, and it's not just statutory law, the laws that legislators are actually passing, it's also case law. When cases go to court, whether it's an eviction case, or maybe it's a lawsuit over repairs, or whatever the case may be, if it gets to state court, a judge will issue a decision, and that becomes precedent. That's case law. Future judges in that same state are going to look to that decision to decide what to do. That means even when the actual written law hasn't changed, frequently the way judges are interpreting it and applying it does change. What we do is we have our attorneys constantly update our leases. And since our attorneys are in court, and constantly seeing what these changing case law standards are, they're in a perfect position to be able to modify this lease for us, as the statutory law and case law changes. It's important to be able to get a tenant on a new lease every year, so you're including all of those changes that keep you protected as the landlord. 

Furthermore, it could just be that you have policies that you want to change in your lease. Maybe you used to have a pet fee of $100 in your lease, but now you want it to be $250. You want to be able to get that tenant on that new lease, so you've got that higher pet fee built in if that tenant decides to get a pet. That's just one example of something that might change. It's not a legal change, it's just a change that you want to make, and you want to make sure that the tenant is on the most recent lease so that that change is in there.

Finally, it's just a better idea from your perspective to be on a current lease agreement. Sometimes we hear landlords say that they're going to only do an initial lease agreement, and then let it lapse into a month-to-month agreement after it expires. You don't want to do that. You always want to have your tenant on a new lease agreement that's actually covering the period of time that you're in, and the reason for that is because judges will favor that. 

An example of why this is important is a case we had last year, where we went to court with a month to month lease. The owner had asked us to do that, and at that time we didn't have a policy against it. We did what the owner asked, and did a month to month lease after the tenant's original lease expired. That tenant subsequently stopped paying the rent, so we had to go to court to evict that tenant. Well, the judge said because it was a month to month lease, instead of an actual written lease covering that period of time, he wasn't going to allow us to have any late fees. He found a precedent buried into some old commercial real estate case that allowed him to do this. If we had had a firm lease agreement, a real lease agreement, that covered that period of time, instead of just a month to month lease after the original lease, then the owner would have gotten several hundred more dollars of late fees that they lost because they were on that month to month lease. That's why we always tell everyone, always be on a current lease, keep it at a one year term, and make sure you're constantly updating that every single year. Don't let it lapse to a month to month lease. Always get a new one signed. 

If you have any questions about any of this, or any comments or anything, please send us an email: support@gtlrealestate.com, and we'll be happy to talk to you. Thanks.

GTL Real Estate
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Senoia, 30276

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