The Renewal Option: Why You Should Have It But Probably Shouldn't Use It
What if I told you there’s a provision in most commercial leases that you should ask for but will likely never be used? I’m talking about the renewal option – sometimes called the “extension option”. Understanding its ins and outs can help a commercial tenant know how it can protect them, and when (and when not) to use it.
What is the renewal option?
The renewal option allows a tenant to renew its lease for a predetermined period of time on terms stipulated in the option language. Most often, the option must be exercised within a specific time window, typically 9-18 months prior to the expiration of the lease.
Typically, the renewal option is guaranteed to be extended at fair market value –usually defined by the rates set by new leases in the building or submarket –but not less than the rent for the last year of the lease. The lease will usually include a definition of fair market value that allows for adjustments based on other economic concessions. To qualify as a true option to renew/extend, the options must be “one-way”, exercisable solely by the tenant instead of by tenant and landlord. What does this mean? In some leases, the tenant retains the option to renew subject to negotiating mutually agreeable terms. This is not a bona fide option, just an option to negotiate.
Why you should have one
Renewal options are indispensable because they offer some protection for tenants, preventing a forced relocation if a landlord wants to lease the space to another tenant or otherwise reposition the space. Renewal options are particularly important if the tenant has invested capital in improvements to the space that will become the landlord’s property upon vacancy. So, if you’re a commercial tenant, you should have this option.
Why most tenants never use it
In most cases, tenants can negotiate more favorable terms as a “free agent” rather than dip into the lease terms to exercise the renewal option. For instance, as defined in most leases, “fair market value” typically doesn’t include concessions like tenant improvement allowances (TIAs) or free rent, or account for a tenant with a more or less favorable credit profile. The other reason exercising a renewal option may not be the right path is that tenants’ needs change over time, and they may not need the same amount of space they did at the beginning of the lease term.
When it comes to renewal or extension options in commercial leases, make sure you have one – but think twice about exercising it. As always, Cresa is here to help you navigate these questions in more detail.