Negotiating a Lease Renewal Option
Most tenants and their real estate agents who negotiate commercial leases accept that many of the terms in the landlord’s “form” lease favor the landlord. One term, however, that favors only the tenant, and which every commercial tenant should seek to include in their lease, is an option to extend the lease term. The reason that said term is only for the benefit of the tenant is that only the tenant gets to decide whether or not to exercise the option to extend on the terms stated in the lease, and if it is not, for any reason, in the best interest of the tenant to do so, the tenant will simply let the option lapse unexercised.
In negotiating a renewal option, the first issue is how many options will be given, and how long each option term will be. A tenant who wants to maintain flexibility will prefer multiple consecutive shorter term options, for example five three year options, as opposed to one longer option, such as a fifteen year option. The next critical issue is the amount of rent to be paid. Oftentimes, the rent is set as a percentage increase over the final year of the lease term, although there are certainly many other possibilities. If the parties wish to set the rent as being “fair rental value,” with or without a “floor” or “ceiling,” it is critical that such term be objectively defined, or that a formula is set forth in the lease for determining such “fair rental value.” An example of the former is to define it is the average price per square foot of for the last three leases executed in the subject shopping center or building. An example of the latter is to define it as the amount mutually agreed to by a two qualified appraisers, being one designated by the landlord and one designated by tenant, and if the two appraisers cannot agree, then the amount determined by a third independent appraiser chosen by the other two. Although sometimes done, it is foolish for the parties to simply provide that the “fair rental value” to be used for the renewal period is an amount “to be agreed upon,” without any further definition, as doing so is a clear invitation to future litigation.
A landlord can protect itself from having an undesirable tenant by including in the lease a requirement that in order to be eligible to exercise the renewal option, the tenant must never have been in material default at any time during the lease term. A tenant may wish to limit such protection by changing it to state that it only applies if the default was not cured, or that if it occurred on multiple occasions, or if it exists at the time of the exercise of the renewal option. A further protection that most landlords will require is that the renewal option be exercised, if at all, during a particular timeframe, such as no earlier than nine months and no later than six months prior to the end of the lease term. Most courts have enforced such provisions, particularly if there is a “time is of the essence” provision in the lease.
About the Author: David Allen, a partner in the Phoenix law firm of Jaburg & Wilk, has been representing clients in both transactional and litigation real estate and business related matters for over thirty years. He is licensed as an attorney in both Arizona and California, and is also a licensed Arizona real estate broker.