Negotiating the Renewal Option

by CoyDavidson on June 27, 2010


Who Benefits from a Renewal Option?

Most commercial leases are long-term in nature, typically 5, 7 or 10 years in length, but also typically contain provisions for extending the lease beyond the initial term. A renewal clause in a real estate lease allows a tenant to decide whether or not to extend the lease once the initial lease term expires. The key concept to remember is that the renewal option is a benefit to the Tenant.

Short-Term versus Long-Term Leases

Before I decided to write this article, I did a quick on-line search of articles written on the subject of the renewal option. In most cases, these articles emphasized the point that Landlords and commercial leasing agents typically want tenants to sign long-term leases and the better approach was to sign shorter term leases with renewal options. I won’t disagree that in some cases a shorter term lease may be a more prudent strategy for some companies; however there are disadvantages to signing short-term leases including:

  • Short-term leases equate to less negotiation leverage and fewer concessions.
  • Tenant improvement allowance: If you need significant improvements to renovate the space to your needs then expect to come out of pocket for the costs. The shorter the lease term, the less the Landlord is going to provide in funds for tenant improvements.
  • The inability to fix rental costs for a longer period and exposure to higher rental rates in subsequent renewal terms.

Most of the authors of these articles recommended asking for renewal options with predetermined increases for a series of renewal options. This sounds great in theory, if you can get the Landlord to agree to what you consider reasonable predetermined rent increases. However, the reality is very few Landlords are willing to give you that flexibility without paying a premium, even in a soft market. In other words, expect those predetermined increases to be rather significant.

The whole short-term versus long-term lease decision comes to down to flexibility and what’s the cost associated with that flexibility. There are reasons businesses sign longer term leases and short-term leases are the exception rather than the rule. Generally speaking longer term leases result in lower costs. More flexibility is sometime necessary and the additional cost or limitations associated with short-term leases is worth the trade-off.

Negotiating a Favorable Renewal Option

Landlords reluctantly grant renewal options because it limits their flexibility to market the space to prospective tenants. However, they typically recognize it’s going to be required in order to complete a lease transaction with most tenants. The “Renewal Clause” spells out when the tenant is required exercise their renewal option, the term of the renewal period and the rental amount and/or the method for determining the financial terms for the renewal period.

What you need to know about renewal options Click To Tweet

Elements of the Renewal Option:

Notice Period: Most renewal clauses require the tenant to give written notice to the Landlord that they are exercising their right to the renewal option within a specified period of time, often 6 or 12 months prior to the expiration of the lease. From the Tenant’s perspective you want to make this notice period as long and as flexible as possible, giving you and your broker time to thoroughly evaluate the market, solicit proposals from competitive buildings and make a good business decision while your option period is in effect.

Term: The renewal clause will state the length of the lease renewal period. If possible when negotiating the renewal clause, ask for the option to renew the lease with different length terms (i.e. 3/5 years or 5/10 years).

Rental Rate: In some cases the renewal clause will have a predetermined renewal rental rate, but the more common approach is to have the renewal financial terms tied to a determination of “fair market value” (FMV).

Fair Market Value: It is important to define in detail the definition of “fair market value” because in essence, this is a negotiation that will take place at a later date. The objective is to leave as little as possible subject to the Landlord’s interpretation of FMV. Does the definition of FMV include accounting for tenant improvement allowances, free rent, and other concessions offered by competitive buildings? Is there a floor for the minimum rent? I have often seen language in the clause that states; “in no event shall the tenant pay less than the current rental amount” Can you get a ceiling on the maximum rent; 95% of FMV? What if the Landlord and Tenant cannot agree on FMV? The renewal clause should also contain a mechanism for engaging a third party arbitrator if the two parties cannot agree to terms.

The Renewal Option Protects the Tenant

In reality, the renewal option provides very little if any benefit to the Landlord. For the tenant it is important because it can protect their rights and negotiation leverage in market conditions or a situation that is tilted in the Landlord’s favor.

  • Another tenant may be willing to pay a higher rental rate than you for your current space.
  • A larger tenant in the building may want your space for expansion.
  • You  may have made a huge financial investment in improvements or infrastructure in your space and the Landlords knows it will be cost prohibitive to move.

If you have a well structured renewal option, it acts as the framework for putting a ceiling on the costs of renewing the lease for your office space. In a soft, tenant-oriented market the renewal option is not as critical. The Landlord wants to you to renew at the best terms they can achieve, but realizes competition for your tenancy and market conditions will prevent them from invoking any predetermined framework outlined in the renewal option.

When you are negotiating your lease it is difficult to predict what business and market conditions will look like 5 or 10 years down the road. If you do not have a renewal option in your lease or it is poorly structured, it could be very costly. However, a well structured renewal option can save you a significant amount of money, particularly in a tight market.

The renewal option may seem secondary to the primary lease terms that are important to your business today. However, down the road the renewal option can have a big impact on your business. It is important to assume that market conditions are going to be in the Landlord’s favor when it becomes time to exercise the renewal option.

Learn more about Colliers Tenant Representation Services

You might also like:

Get my posts via e-mail: here


Kcali December 27, 2013 at 1:06 am

In a typical ground lease; can a lessor ask for “option fee” if tenant elects to exercise an option to extend? The Lease indicates a 2 3-yr option but the lessee is requesting for 3 5-yr option; the Lessor will grant it in an amendment to the Lease provided that the Lessee will pay an option fee. In general (by law), is legal to ask option fee?

Also, Lessor has draft the amendment to Lease through his lawyer, can he ask the Lessee to pay for its cost (attorney’s fees and cost)?

Thank you.

Bluewater April 22, 2014 at 10:20 am

I need to renew my boat slip lease. This is a seasonal marina that usually only has a full marina “in season”. They LOVE their few year-round tenants to help pay the bills in the off season. This month ends my second 1-yr lease with them and I want to do something like a 5-yr lease with a 1-yr option so that they agree to keep my rate the same, but I can get out if I need to at the end of any of the 1-yr lease terms. Is this possible? I want the security of knowing I have the slip at the agreed price for 5 yrs and I doubt they will complain about that, but I may need to get out sooner. Any suggestions?
Thank You!

bob August 19, 2015 at 10:29 pm

in the renewal option can the landlord force me to make changes in my business

Arleen jill August 27, 2015 at 7:06 pm

I have an option to extend my lease for 5 years. Although I am not in default and have given notice I want to extend the lease, my landlord says he does not feel like leasing the property any longer and will not extend even though I have put a lot of money in renovations into the building. Do I have a case to force him to comply with the lease?

landlord September 1, 2015 at 8:45 am

Go see a lawyer. You have the option to extend the lease, the landlord cannot prevent you from doing so, but he can make life difficult.

He may say that he longer wants to rent the space, or he may not want to rent to you. In any case, you have the option to renew. You have notified the landlord within the prescribed time. You have rights and if he wants you out, it will cost him. See a lawyer.

Ekers November 30, 2015 at 8:37 pm

my father owns a mechanic shop the lease expire 4/2014 he did not write a extended lease agreement or sign any document to extended his lease the owner of the property told him verbally he can stay until 4/2015. 4/2015 property owner agreed to let him stay until she is ready to build. Code enforcement came on 11/18 said all electrical is wrong and needs to be rewired 10k job they basically said repair or we shut you down. We found a new property but property owner is saying by sending her a check after our lease expired we agreed to rent for another two years which makes the lease ending 4/2016. Does she have a case?

Samuel January 15, 2016 at 12:03 pm

I own a Martial Art gym and the landlord was aware that there will a lot of noise for this kid of business. My neighbour who is a walk-in clinic have been complaining to the landlord about the noise and now that we are up for renewal the landlord is not willing to resign without me installing soundproofing wall which will cost me a fortune and which will also mean my business will be closed during the installation period. BTW i do have the renewal clause of 5 to 10 year with the landlord. My question is, can the landlord not resign if I don’t agree to install the soundproofing wall. I feel like they are favouring the Clinic and making it difficult for me.

Charlie Smith January 31, 2016 at 10:14 pm

My lease was up in August 2015. I told my landlord I would sign a lease if she would lower the rent, she agreed via text. Then about a month later she was in the process of selling her property (shopping center with a stand alone restaurant that I rent) and informed me the new landlord did not want any new leases signed. She never took her offer off the table. Then at the end of Jan 2016 she informed me via text she would be raising the rent in 3 days because she had 2 other people interested in the property. I reminded her of her offer of lowering the rent and then telling me via Facebook the new landlord didn’t want new leases signed. I sent her screen shots of the two messages. She claimed I didn’t accept her offer though in reality she actually accepted my terms of lowering the rent. I did tell her that if her new tenants wanted to buy me out I would sell (she never responded to that) I finally did agree to her terms of her written offer (text) of raising the rent and agreed to sign a lease. She is now balking and I’m sure she is not going to let me renew my lease.

Some history, last winter she took our heater out to install a new one in November 2014. The heat was not installed until March 2015. This required me to use electric space heaters causing my electric bill to double and triple which made me incur a huge expense. I was unable to pay rent and she agreed that I could pay it when I could. She also made some compensation forgiving some part bills totaling around 2000.00. I caught the rent up and actually paid 4 months in advance. The cold temps in the building also caused me to lose business, close 7 different times due to frozen water pipes and pipes that had burst.

My question is since she made the offer via text and I’ve accepted is she required to renew my lease as offered? I am located in Ohio.

Coy Davidson February 1, 2016 at 2:46 pm

Charlie, in my opinion no she is not required to renew your lease. Typically unless you have a written agreement executed by both parties (either a lease agreement or amendment to the lease) she could rescind her offer.

In some cases if you had an iron clad renewal option written in to your lease then you might be able to renew your lease. Note I am not an attorney, but just going on my knowledge of what is typical.

TJ Sider March 2, 2016 at 5:10 pm

Hi, If I have exercised my option to renew, but suddenly have a better space become available, can I take my renewal off the table? I have not signed a new lease, nor even been presented with a draft.

Coy Davidson March 2, 2016 at 10:30 pm

TJ I would have to read the language of your renewal option to even form an opinion. That being said it may be a legal question. Generally speaking I would think you would have to execute a new lease or an amendment to your existing lease for the renewal to be in effect.

Lori Nails March 17, 2016 at 12:52 pm

If we have an accepted offer on a commercial building for sale and were in the process of renegotiating a new lease for current tenants before closing-is this legal?

Alex Lundstrum April 30, 2016 at 7:06 pm

My lease ends 5/14 and I plan to renew for another year. The rent increased for the upcoming year. My landlord told me that on 5/1, the rent due would be the full monthly amount stated in the new lease. Should this amount be prorated to reflect that the original lease extends through half of the month of May?

jim August 14, 2016 at 9:30 pm

My 10 yr lease has expired and when I approached the landlord to renew, he said he would if I paid him $20,000 or he would rent it out to someone else. I don’t want to move as I have built up a decent business in that location.

jim August 14, 2016 at 9:31 pm

Is this even legal and what are my options?

lawrence March 16, 2017 at 7:43 pm

If ive said yes id like to take may say 1 year extension but things have now changed and im happy to leave at end of current lease can i get out of the extension?

lawrence March 16, 2017 at 7:46 pm

Coy i have the same issue what type of things would you be looking for in the agreement to stop this?

Rajpal Singh April 8, 2017 at 7:20 pm

Hi I have 5 year lease and 5 year option for the lease but landlord don’t extend my lease what can I do.

Nancy Shelley April 15, 2017 at 8:10 am

The original lease had an option to buy with set prices each of the 5 years of the lease. The lease was renewed with annual rental amount posted each year but the amount of purchase was not mentioned. Now, we have had an offer to buy from someone else at a higher rate than what the original lease stated. The tenant now wants to buy the building 3 years after the original lease expired only because we have had another offer to sell at a higher rate. Does anyone know if we Must to sell to the tenant at the rate in the 1st lease?

56274 June 14, 2017 at 7:58 pm

does the tenant rep get a commission on a renewal paid by the landlord if the TR wasn’t in on the original lease.

Coy Davidson June 15, 2017 at 8:45 am

Often they do, but the Landlord does not have to agree to this. Whether the Landlord typically agrees to this can vary by market and property type. In any case ultimately the tenant rep and Landlord have to come to that agreement.

Steven Hughes August 12, 2017 at 11:58 pm

I purchased a model home and leased it back to the builder at a discount. Upon expiration of the first year, the builder has two six month options to renew; effectively adding an additional year. Since the lease states “extension” of duration does that include the rental rate? Because the lease does not specify the terms for rate and I don’t want to offer a discount any longer after the first year.

Please advise!

Tracy January 17, 2018 at 4:29 pm

We have a three lease with an option to renew for another three years. In our lease it stipulates that we must give a 60 notice if we intend to exercise the option to renew. No where in our lease does it say that we will have a rent increase nor does it mention that a rent increase would be tied to the cpi or Market Rent method. Since there is no mention of a rent increase or method to establish a rent increase it seems to me that we can exercise our option to renew without any rent increase.

{ 7 trackbacks }

Previous post:

Next post: