What Is A Renewal Option?
A renewal option, also known as an extension option, is a provision typically found in commercial real estate leases that allow the tenant to extend their lease for an additional term upon its expiration. They are usually a negotiated point and can be an easy concession for Landlords to give in some instances. The rate is often predetermined but is typically tied to the “fair market value, which can be somewhat ambiguous. Renewal options ordinarily last for one additional period. Still, they can be for multiple additional periods (for example, two additional 5-year extension periods) in longer or larger leases.
When Should a Tenant Push For A Renewal Option?
These options can be advantageous for tenants seeking stability and continuity in their occupancy of commercial space, mainly if the location is prized or critical to the tenant. A tenured broker will know when a renewal option will be valuable to clients and will also push to include arbitration and define fair market value.
Some examples of when a renewal option may be valuable include:
- An office tenant with stellar views in a top-tier building.
- A logistics business leasing that is planning to automate a facility with an ideal location for distribution.
- A famous retail tenant in a free-standing building along major thoroughfares.
In short, a renewal option helps to avoid disruption. It provides tenants stability and predictability without committing to a guaranteed rent term or period.
Are there Drawbacks To A Renewal Option?
With advantages come disadvantages. Tenants should be aware of the limitations and disadvantages of renewal options. While renewal options provide flexibility, they are often limited to the specific deal terms, square footage, and lease terms. If the tenant’s needs have changed and the lease terms need to be renegotiated, the renewal option will not be valid in many cases. There is also a high likelihood that the rent will increase due to the renewal. Landlords will typically try to keep rents higher than they last were in the lease or tie it to a fair market value on the landlord’s floor.
Benefits Of A Renewal Option
Tenants:
Stability and Predictability: Renewal options assure tenants that they can continue occupying the space for an extended period, offering stability for their business operations.
Negotiation Leverage: A renewal option can give tenants leverage during lease negotiations, demonstrating their commitment to a long-term relationship with the landlord.
Avoiding Disruption: Renewal options can help tenants avoid the hassle and cost of relocating their business to a new space when the initial lease term expires.
Landlords:
Flexibility and Control: Landlords retain flexibility in managing their property by having the option to renegotiate lease terms or lease the space to a different tenant upon the expiration of the initial term.
Maximizing Revenue Potential: Landlords may prefer not to commit to long-term leases with fixed rental rates, as it allows them to adjust rental rates to reflect changes in market conditions and potentially maximize rental income.
Space Optimization: Landlords may have strategic plans for the property that necessitate reconfiguring or repurposing the space, which could conflict with the tenant’s desire for renewal.
Disadvantages Of A Renewal Option
Tenants:
Potential Rent Increases: Landlords may include provisions for rent escalation in renewal options, meaning that the rental rate could increase upon renewal, possibly at a rate higher than market value.
Limited Flexibility: While renewal options offer stability, they can limit tenants’ flexibility to relocate or renegotiate lease terms if their business needs change.
Dependence on Landlord Approval: Renewal options often require the landlord’s approval, which means that the landlord could refuse to renew the lease or impose unfavorable conditions.
Landlords:
Tenant Retention: With renewal options, landlords can avoid losing stable, long-term tenants, which could lead to periods of vacancy and income loss.
Negotiation Power: Including renewal options may weaken the landlord’s bargaining power in lease negotiations, especially if the market favors tenants.
Limited Future Planning: Landlords may need more certainty in planning future developments or leasing strategies if existing tenants exercise renewal options, particularly if they have alternative plans for the property.