Most commercial real estate leases have an option to extend the lease once the initial lease term expires. This clause in the lease allows the tenant to decide if they want to continue renting the commercial space. However, as a landlord, it’s good to remember that in most cases, a lease renewal option favors the tenant.
Let’s look at some ways to negotiate a lease renewal option that is favorable to both tenant and landlord.
What you should know about renewal options
The renewal clause in commercial real estate leases lets the tenant know what they need to do to renew the lease. This includes the renewal period, the amount of rent, and how to determine the financial terms for the period.
The lease renewal states clearly what is the period of time whereby a tenant should give written notice that they want to renew the lease. This is usually 6 months to a year before the existing lease expires. Making sure that this period is as long as possible gives commercial real estate brokers enough time to evaluate the current market.
Terms of renewal
The tenant will also want to know how long the term of the renewal will be. For example, many landlords offer a shorter lease at the start with options in a renewal lease for a longer period of time. For example, an initial lease of 3 years with an option of a 5-year extension. This can help to protect both landlord and tenant ensuring that the commercial space will be occupied.
Because markets fluctuate and rents increase, it is best to include a renewal rental rate that is “fair market value” (FMV). This prevents a situation where you can’t increase the rent after the renewal. It allows both the landlord and tenant to negotiate what is the fair market value of the lease renewal.
Regarding the FMV – it’s also necessary to include necessary clauses to ensure that there is no ambiguity when it comes to the renewal. For example, the renewal clause could state that under “fair market value” terms, the tenant cannot pay less than the current rent. You should also state how building improvement costs will be calculated into the “fair market value.”