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Commercial Lease Renewal Option

Posted by Capital Retail on June 4, 2018
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As real estate brokers representing retail tenants, we negotiate with the landlord to have lease renewal options also called “extension terms” included in the primary lease. Renewal options are mostly to the benefit of the tenant and not the landlord.

A renewal option in the lease is up to the tenant to exercise and there are often very specific dates the tenant must follow to notify the landlord their desire to renew the lease or the option will be null and void.  For example,  “Tenant shall give written notice to Landlord to be received by Landlord not less than twelve (12) calendar months but not more than fifteen(15) calendar months prior to the expiration of the initial Lease Term.” It’s up to the tenant to exercise  and is especially powerful if the extension has a “fixed rate” which explicitly states what the rent will be during each year of the extension period. the original primary lease.  These are the best form of renewals but are rarely approved by Landlords. Tenants want to know exactly what the rent would be if they exercised their option to extend or renew the lease.

In strong markets like Washington D.C., market rent can increase dramatically and the Landlord may mistakenly agree to affixed rate renewal that is below market. This is why Landlords want to make the renewal at “Market Rate”.  Renewal options give the tenant flexibility in deciding how to proceed when their initial term is up. Should they renew or move? An option to renew a lease is not a requirement to renew. That option is solely up to the tenant to decide if they would like to elect to exercise the option to renew.  For tenants, fixed rental rate renewal options with no ambiguity are most valuable.   If a retailer wants to sell their business, having at least five years left of lease term is important to buyers. Buyers of the business want to know what the rent will be long after you have sold the business to them.

A clear fixed tenant option would be “the renewal rate shall be three percent over the last year of the initial term lease and shall increase three percent annually thereafter during the option term”. On the other side, the landlord will try and negotiate the rental rate to be at “market value” and to be as open as possible.  The determination of market rate is also important to define. The landlord may start out negotiations by stating they will determine market rate.  Landlords are parties to the lease and therefore could not give an unbiased determination of what market value will be.

Often market value will be determined by using the three-broker method. An example of determining the option rental rate might look like this “Landlord and Tenant shall be responsible for paying their respective brokers.  If the higher of the two (2)  Broker Opinion of Value(BPO) is less than one hundred ten percent (110%) of the lower BPO, then FMR shall be deemed the average of the two  BPO’s.  Otherwise, the two (2) brokers shall appoint a third broker and the third broker shall also appraise FMR.  The fee for the third broker shall be paid one-half by Landlord and one-half by Tenant. The FMR shall be deemed the average of the two determinations that are closest to each other. ” In summary, tenants should negotiate to have an option to renew in their primary lease even if it’s at market rate.

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