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Your commercial lease renewal is coming due and you would like to renew, extend or renegotiate the lease. Here is what you need to know. You actually may not have the right to renew your commercial lease.
Unlike residential real estate in which laws generally favor the resident, commercial landlords are not necessarily under the obligation to renew your lease.
It could be that they have another tenant or use in mind for your space at the expiry of your term. There could a growing tenant in the building that will move out of the building if the landlord cannot satisfy their demand for square feet.
Before reading the rest of this lease renewal article, it may be worth spending the time with this quick video tutorial:
Step 1: check the lease. You can find out under "Option to Extend", or "Right to Renew" (or you can have a commercial lease expert review the lease for you).
Step 2: what is the notice period? Rights to renew usually have a deadline - usually 6 months prior to the expiry, but in some cases for small tenants it can be three months and larger tenants are typically 9-12 months.
Step 3: is the extension rate fixed or fair market rent?
Now that we have covered the basics, let's look at a sample commercial lease renewal clause (taken from a recent lease from Los Angeles, California):
The Tenant shall have the option to extend the Term of this Lease for a further term of five (5) years ("Extension Term"). Such extension shall be on the same terms and conditions as contained in this Lease, except that:
Such right to extend shall be exercisable by notice to the Landlord by not later than nine (9) months prior to the expiry of the original Term hereof, failing which such right shall be null and void and forever extinguished.
Translation: all of this is normal. When exercising an option to extend there is no further option thereafter.
The lease clause goes on to read:
ii) The Base Rental for the Extension Term shall be the greater of:
As used herein, "Market Rent" means the annual rental which could reasonably be obtained by the Landlord for the Leased Premises from a willing tenant or willing tenants dealing at arms' length with the Landlord in the market.
Note: this is a rent floor.
Most landlords will agree to remove the wording that calls for the extension rental rate to be at least equal to that in the last year of the term.
After all, market should be...market!
Imagine what a landlord would say if you wanted to negotiate a rental rate that was no MORE than the last year of the term - they would not cap themselves, and you should not agree to a guaranteed minimum amount for the landlord.
If the market goes down, you should be able to benefit on the renewal lease term.
There are no hard and fast rules for triggering the option to renew the lease.
It will be whatever it says in your lease.
The normal time periods are:
1. At least 12 months before the lease expiry (common for big tenants)
2. 9-12 months before expiry
3. 6-9 months before expiry
If the renewal notice date is tied to the lease anniversary, is that date clear?
For example on a 5 year lease, if the renewal notice date has to be provided by the 4th anniversary of the lease, and the commencement date was a "floating" date (not the first of the month, but whenever the landlord was able to provide possession), does everyone know about and agree to that date?
As a general rule most shopping mall leases and small retail leases are at 6-9 months for renewal notice.
Office tenants over 5,000 square feet typically have 12 months, just like industrial tenants over 20,000 square feet.
This is the least understood part of commercial lease renewals.
Unless otherwise stated in the lease, the tenant is under no obligation to notify the landlord that they will be vacating at the expiration of the lease.
It's just courteous to let the landlord know so she can begin the market the space to the next tenant.
Here is the problem with the conventional system of renewing a commercial lease - you first commit to renewing, and only THEN do you find out what the rental rate will be.
It's like having a set of golden handcuffs.
The good news is that nobody gets your space except for you, but you don't know what the price is until after you commit.
Did you also notice that in the example above there was no arbitration right?
That is the case of so many leases, and there is what happens to many business owners:
What a mess!
There are two strategies to avoid this.
1. Prepare an offer to lease, letter of intent or renewal proposal. They are all synonyms and they just mean a document that outlines the business terms you would like to see moving forward. They are all binding documents - you should have a cooling off clause inserted to ensure that you can negotiate with these documents on a conditional basis and then sign a waiver letter later on.
The tenant's condition could read something like this (taken from a recent lease in Miami, Florida):
This Offer to Lease is conditional upon the Tenant obtaining the approval of its Senior Management within five (5) business days of acceptance of this Offer to Lease by both parties. Should the Tenant not notify the Landlord in writing within five (5) business days from the date of conditional acceptance of this Offer to Lease by both parties of its Senior Managements' approval, then this Offer to Lease shall be null and void and of no further effect.
2. Exercise the option to renew, with one caveat - insert what the rental rate will be.
This is a "work-around" solution.
The renewal right clause was not designed to work this way, but your landlord should be fine with it if he is truly interested in keeping you as a tenant.
The commercial lease renewal letter could read something like this (taken from a recent lease in Houston, Texas):
Further to clause x of our lease dated x between <tenant> and <landlord>, we hereby exercise our option to extend the lease for 5 more years, subject to the net rental rate being $X for the extension term.
Option 1 above is a wise move if there are other items you would like to renegotiate in the lease - like some free rent, or a cash allowance to improve your premises.
Option 2 is the better move if there is competition for your space or if the landlord wants to tinker with your lease and you have some favorable clauses you would like to keep locked in.
The biggest issue with exercising your option to extend the lease is that you cannot improve any of the terms of the lease.
For instance, what if you need to renovate your space and you want a tenant improvement allowance?
Or some free rent, more parking, a right to cancel the lease, etc?
Exercising the right to renew means the lease lives on with only the term of the lease and the net rental rate to be changed.
Therefore if you can just work out a new deal, then those items can be on the negotiating table.
There are really three risks in missing the notice date for renewal:
1. You have no right to stay in your premises, and the landlord has another tenant to fill the space (usually an expanding tenant or one that is willing to pay a higher rent than you).
2. Your landlord does not have another tenant, but is pretending she does to increase the rent.
3. The landlord wants to sell or redevelop the property and can do so when your lease expires.
In checking the notice requirements in your lease, check for:
1) Are the dates for notice of exercise absolutely clear?
2) Are the parties to give notice clearly identified?
3) Is the landlord required to provide the tenant notification of the tenant's notice deadline?
4) Are the notice periods reasonable, or does it require the tenant to provide notice too far in advance of the lease expiry?
5) If the notice date or periods are tied to the lease commencement anniversary, is that date clear?
So regardless of what method you take to arrive at a new commercial lease agreement (exercising the right, or just negotiating a new deal), it is better if that negotiation is completed before the expiry of the notice period.
Only if the lease says that the renewal can be for "all or part" of the premises.
Most landlords by default will refer to the renewal right as a right that applies to "the Premises", which is defined as the entire space.
This is important because if you want to stay in your space and renew, but do not want the entire premises, then your renewal right is null and void.
If your landlord is not willing to compromise on this, then perhaps you can negotiate for a percentage (for example, you have the right to renew if it is for at least 80% of the Premises).
Landlords like to avoid providing the right to renew for a part of the space, as it introduces logistics.
For instance, who has the right to decide what portion of the space the tenant stays in - the tenant or the landlord?
Who pays for the demising of the space?
This is easier if the tenant is renting multiple units and everything is clearly defined upfront.
It depends on what it says in the lease.
Most landlords include the lease renewal qualifier of "provided the tenant has not been in default of the lease".
This gives the landlord the ability to take away your renewal right if you were in default just one time.
Other leases are more forgiving where they would require that you are not consistently in default, or as long as you are not in default as of the date you are renewing the lease.
If your lease is silent on this that should work in your favor.
By and large, no.
Most leases have within their template that the right to renew is a right solely provided to the tenant, and shall not be a right inherited by the subtenant.
Your sublease is an agreement between you and your subtenant, and the landlord is not a party to it - they just approve it.
This can be overridden by you, your subtenant and the landlord if all three parties are in agreement.
For this reason sublets are one day less than the full length of your term.
Although rare, some commercial leases have automatic renewal clauses.
They are usually an alternative to completing a longer term deal.
For instance, a tenant and landlord may agree to a 5 year term with an automatic renewal right for another 5 years, instead of a 10 year term.
The rental rate for the renewal term is usually explicit.
The lease automatically renews, UNLESS the tenant notifies the landlord otherwise.
Such a structure provides the tenant in this case with protection on a 10 year term with known rental rates but the tenant can still get out of the lease at the 5 year mark.
Well, we thought you'd never ask :-).
You an hire a commercial real estate broker (who works on commission), a commercial real estate attorney whose incentive is to rack up billable hours, or you can turn to an online commercial lease review company (hint: that's us).
Here is a quick video from one of our founders on the advantages of hiring an online advisor:
The goal here is to provide enough guidance on a formula so that both parties can find enough comparables to come up with a reasonable number for fair market rent.
We would suggest the following (taken from a recent lease in New York):
The Base Rent for the extension period shall be at fair market rent, as defined as comparable to similar premises used for a similar purpose in comparable buildings in the immediate area.
This just comes down to your negotiating leverage.
What is common is a term and a renewal rate that are the same length (5 year term, right to renew for 5 years).
If your business has uncertainty and you have an agreeable landlord, you could achieve several rights to renew at one year each, though this does not create much value for the landlord (property value is achieved with tenants committing to lengthier terms).
Big tenants are able to achieve multiple 5 year rights (for example, a grocery store may do a 10 year or 15 year deal, with 5 rights to renew at 5 years each).
If you are negotiating a deal right now, you could also structure the deal so that you do a longer term with a right to cancel.
For example, instead of a 5 year term with a right to renew for 5 years at fair market rent, you could commit to a 10 year term with rental rates you know for the entire 10 years.
Then have a right to cancel at the 5 year mark.
The landlord may want a termination penalty, especially if he is paying real estate commissions and/or is spending money on the space.
There really are only a few scenarios:
1) You have a fixed renewal right that is below market and your landlord would prefer to achieve a higher rental rate from a new tenant.
2) There are other tenants in the building who need expansion space and your landlord would prefer to offer your space to them.
3) Your landlord does not like your use (or you!) and would prefer to have a different tenant in your premises.
4) There is more value for the landlord to sell the building or redevelop the property.
If any of these apply to you, it may be wise to actually exercise the option, rather than deal with a landlord who will be impossible to deal with in simply working out a new lease.
Many leases are silent on a renewal right. If you did not ask for it, most landlords are not going to volunteer it.
It is not favorable for the landlord - they may have other plans for your space at your expiry, so an extension triggered by you (for your benefit) does not automatically mean it is good news for the landlord.
So in the event you do not have a right to extend the lease, then the landlord can refuse acceptance of your renewal letter.
If you do in fact have a right within the lease, then you are fine, and the rules spelled out in that right will govern.
Just keep in mind that when you exercise your right to renew, the renewal right itself is the only clause that does not survive into the extended term.
You use it up in the process of renewing.
That is why you would need to negotiate for multiple renewal rights at the letter of intent stage.
Yes. It is rare, but such an obligation can be found within commercial leases. Here is an example from a lease we received from Australia, in which the tenant was obligated to spend $25,000 in renovations:
Refurbish And Upgrade. In the event that Tenant exercises its option to extend the Term of this Lease, Landlord may, by written notice to Tenant within thirty (30) days after receipt of the Election Notice described in Section 3.4.1, require Tenant, at Tenant’s cost, to expend up to Twenty-Five Thousand Dollars ($25,000.00) to renovate and refurbish the Premises as reasonably necessary to maintain the Premises as a first-class store consistent with the Design Guidelines. Such refurbishment or renovation may include, in Landlord’s reasonable discretion, new flooring, painting, new wall covering, new tenant fixtures, storefront and signage. All such work by Tenant pursuant to this Section 7.5.5 shall be in accordance with this Section 7.5 and shall be completed within six (6) months after the date of Landlord’s notice.
If you miss your notice period for renewal, your extension right is extinguished.
If both parties want disregard the notice day and proceed with negotiating a renewal, then so be it.
Failing that, the lease contract just ends.
You no longer have rights to the premises on the day after the lease expiry.
You give the keys back and that's that.
Staying as a month to month tenant requires the permission of the landlord, as they would like to lease the space to another tenant that is willing to commit to a longer term lease.
Therefore this holding over by you will come at a penalty. Most leases are at 200% of the base rent and most landlords agree to reduce that down to 150%.
Once you exercise your renewal right, or work out a new firm and binding deal, the onus is on the landlord to prepare and provide a formal lease amending agreement.
This document will act as an appendix to your existing lease, and all the terms in your existing lease will survive, except for what is outlined in the lease amending agreement.
Usually you exercise your renewal, the landlord then provides the rental rate and that's it - you must accept the rent.
Some leases have an arbitration right, though the landlord usually holds this back and only provides an arbitration right if a tenant asks for it.
A good arbitration clause will have both sides appointing a commercial real estate expert with at least 5 or 10 years of experience and they will jointly pick a 3rd arbitrator. All of this should be within specific timelines (for example, within 10 business days of the tenant rejecting the renewal rental rate, each party will pick a 3rd party arbitrator, and the arbitrators will have 10 days to pick the final arbitrator).
Then the final arbitrator will have a period of time in which to render a final and binding renewal rental rate.
The total cost is usually split 50/50 between the landlord and tenant, though some leases may penalize the party that ends up "losing" the negotiation as an incentive to have everyone acting as reasonably as possible.
Only if the lease is specifically written that way, but that would be extremely rare. It is a right of the tenant.
More common would be a joint renewal right, in which the wording would speak about a mutual agreement to extend the lease.
This is not really a commercial lease renewal right - it effectively is taking away the right to renew while trying to trick the tenant into believing they have a valid right.
The landlord simply will not exercise their part of the bargain at the time of renewal.
It depends on what is in the commission agreement that was signed between the real estate broker and the landlord. It is an "old school" move to for the broker to include a commission if the tenant triggers the renewal right.
The broker wants to be fairly compensated on the lifetime value of what it brought to the table for the landlord (your tenancy). Therefore if you exercise your commercial lease renewal right, then the broker would love to get compensated for that.
The opposite side of that is the fact that your broker was representing you in the negotiation, not the landlord.
When it comes time for you to trigger the option to renew, there is no value a broker brings to the table in that process. You also may want to have another broker represent you and may want that broker to renegotiate the lease on your behalf, without formally exercising the option to extend.
In this case the landlord is in a difficult position if they agreed to pay the original broker in the event you stay for an extension of the lease.
Layered on top of this is the fact that technically the commission agreement is between the landlord and your broker, so although it affects you, you are not a party to that contract.
This scenario plays our more often in big office leases where the commissions are more significant. It is very rare in small shopping mall, retail and storefront leases.
If you do not have an arbitration right in your commercial lease renewal, then your landlord could just be unreasonable in determining fair market rent.
Here is a great example from a lease we reviewed in Seattle, Washington that goes into great detail on the steps required for both parties to arrive at a fair market rent and what the arbitration steps are if the landlord and tenant will take if they do not see eye to eye.
A landlord could have performance metrics that dictate whether or not you can qualify for renewal eligibility.
This comes up in percentage leases, as the landlord may be able to fill your premises with another retail tenant that could have stronger sales, and therefore higher revenue for the landlord.
Be sure to check your lease to see if this may apply to you. Here is a sample clause from a lease we received in Atlanta:
Option Right. So long as Tenant meets or exceeds the Gross Sales Threshold (defined below) for the eighth (8th) Lease Year of the initial Term, the original Tenant named herein and its Permitted Transferees (as defined in Section 14.8 below) shall have the option to extend the Lease Term for one (1) period of five (5) years (the “Option Term”), subject to and in accordance with the terms and conditions set forth herein. Tenant may exercise such option only by written notice to Landlord as provided below, provided that, as of the date of delivery of such notice, Tenant is not in default under this Lease beyond the expiration of any applicable notice and cure period set forth in this Lease, and has not previously been in default under this Lease beyond the expiration of any applicable notice and cure period set forth in this Lease during the prior twelve (12) months. Upon the proper exercise of such option to extend the Lease Term, as it applies to the Premises and Tenant’s license to use the Common Indoor Seating Area, shall be extended for a period of five (5) years, provided that at Landlord’s option it shall be a condition to such extension of the Lease Term that as of the end of the original Lease Term Tenant is not in default under this Lease beyond the expiration of any applicable notice and cure period and has not previously been in default under this Lease beyond the expiration of any applicable notice and cure period during the prior twelve (12) months. The rights contained in this Section 2.2 shall be personal to the Original Tenant and its Permitted Transferees and may only be exercised by the Original Tenant or its Permitted Transferees (and not any other assignee, or any sublessee or other transferee of the Original Tenant’s or its Permitted Transferee’s interest in this Lease) if the Original Tenant or such Permitted Transferee occupies the entire Premises. “Gross Sales Threshold” shall mean annual Gross Sales of at least $800,000 during the eighth (8th) Lease Year; if Tenant does not have Gross Sales at least equal to the Gross Sales Threshold during the eighth (8th) Lease Year, then Tenant shall not have any option to extend the Lease Term for the Option Term. “Gross Sales” as used herein shall have the meaning given in Section 4.5 below.
Simply exercising a commercial lease renewal right can mean that a tenant will miss out on lease incentives such as free rent or a tenant allowance, and will not have the ability to improve or remove existing lease clauses (such as removing a personal guarantee).
It is normally the case that a tenant is better off simply working out a new lease arrangement by negotiating with their landlord rather than triggering the option to renew.
Still stuck on how to renew your commercial lease? Check out this video to see how Lease Ref's process can help you (warning: it's a super duper serious video):