What Is An Expansion Option?
Expansion options are clauses in real estate leases that grant the tenant the right to lease additional space within the same property or complex, typically on pre-negotiated terms. These options can benefit tenants by providing flexibility to accommodate expected or unexpected future growth and changing business needs without relocating. However, landlords can view them as detrimental because they limit their ability to fully control the property and its leasing terms.
Types of Expansion Options
Continuing Right Of First Refusal
A continuing right of first refusal (“ROFR”) is the tenant’s right to lease expansion space in priority to other third parties under the same terms and conditions as the third party. It acts primarily as a protection for existing tenants, allowing them to first look at a third party’s terms to decide if they’d like to take the same deal the third party has.
Right Of First Offer
A right of first offer (ROFO) is a provision that grants another party the opportunity to purchase or lease an asset before it offers the asset to others. Essentially, the ROFO holder has the first chance to buy or lease the asset at the specified terms and conditions. However, the holder is not obligated to accept the offer; they merely have the privilege of being the first to consider it.
A right of first offer differs from a right of first refusal because a right of first offer is presented to a tenant or buyer before they offer it to other prospects.
Non-Exclusive Expansion Option
Typically reserved for more extensive or high-quality prospects, a non-exclusive expansion option or non-exclusive right to lease allows a tenant to lease expansion space at the same terms and conditions as the existing lease terms. This right is for a specified period, with the concessions pro-rated based on when the tenant exercises it. Landlords retain some flexibility because it does not preclude them from leasing space to other prospects.
Preferential Right To Lease
A preferential right to lease is another form of non-exclusive right to lease. However, it offers the tenant the preferred right to rent a space in the event a third party tries to lease the space. Suppose a prospect is looking at a space. In that case, the landlord must first provide the tenant with the right to rent the space under predetermined terms and conditions before moving forward with another tenant. This right is typically rare because it puts the landlord in a precarious position where it must offer terms to an existing tenant and potentially lose out to longer-term, more significant square footage deals than the tenant may take.
Exclusive Expansion Option
This option is often reserved for very high-quality tenants and larger blocks of space for a limited period. The exclusive expansion option guarantees a tenant the right to expand into additional space within the property or complex if they meet certain conditions. This option is highly beneficial to tenants as it ensures they have priority over any other potential tenants for the specified expansion space. The right is typically only issued when a tenant has significant leverage in lease negotiations with the building owner and where the lease being pursued to get it is substantial in nature.
Guaranteed Takedown
A guaranteed takedown is a provision commonly found in commercial real estate lease and development agreements that allows a tenant or buyer to take possession of or lease a certain portion of space after a specified timeframe. It is typically not a right to lease but can act as a delayed takedown to allow tenants time to plan and fill the space before they take on additional rent obligations.
How Tenants Benefit From Expansion Options
Flexibility: They provide flexibility to accommodate future growth or changes in business needs without the hassle of relocating.
Cost savings: Tenants may be able to secure expansion space at predetermined rates, avoiding potential rent increases in the future.
Strategic advantage: They allow tenants to secure prime space within the same property or complex, maintaining proximity to existing operations and customer base.
How Landlords Can Use Expansion Options
Reduced flexibility: Landlords may find it challenging to lease space to other tenants if expansion options grant the existing tenant priority.
Potential revenue loss: Landlords risk losing potential rental income if expansion options result in the existing tenant occupying more space at favorable terms.
Complications in leasing strategy: Expansion options may complicate the landlord’s leasing strategy and ability to maximize rental income from the property.
