Prospects change and when they do, you want the tools to grow, shrink or redirect a business. Having lease options in-hand will help you adapt when you need to.
When leasing space, tenants and landlords want options to accommodate shifting needs.
Let’s run through five options commonly negotiated in offers to lease: Renewal, early termination, expansion, relocation and contraction. These are not exhaustive.
Landlords and tenants want a mutual commitment to a term certain to plan and budget going-forward. The landlord may also need the certainty of the rent stream to finance the property. Usually, a lease term runs five or ten years but there’s no magic to that number.
Generally, the less the cost is to fit-up the space, the less term can be and the greater is the cost, the longer the term will be. Renewal options (one or more) give the tenant the right to extend the original term by a defined further period. These options can provide comfort to the parties by establishing terms certain (like rent) or can be on rent terms to be negotiated (failing which, the parties either arbitrate or the option fails).
Tenants need to be careful, these options usually have advance notice provisions and if there are missed, the tenant can lose it’s bargained for right. Commercial tenants who crave location (i.e. retail or food and beverage) should negotiate multiple options. On the other hand, landlords with great locations want to maximize the rent payable for valuable space and therefore minimize automatic renewal options.
Tenants with good covenants can negotiate options to terminate a lease before the end of the initial term. Generally, there is a cost associated with the exercise of that option and the option has a brief, one-time window to be exercised. These options don’t favour the landlord but can be cost neutral. The advantage of this option for tenants is that is provides a cost certain to terminate a project or a line business that would already be budgeted. Like renewal options, you need to work with your broker and lawyer to be clear about timing and exercise.
Landlords want the option to relocate tenants in their building or project to maximize the efficiency of the space available and be able to move in or expand other larger tenants. Multi-tenant buildings will have these clauses. It will be difficult to negotiate this out for small tenants and leases with low fit up costs. Moving is disruptive for tenants but generally landlords offer some compensation for the direct costs of relocating. Tenants will want to negotiate to ensure a broad range of costs are covered and that the relocation is carried out in a manner that minimizes disruption to the tenant.
Needing more space is a good sign that business is growing but getting that space can be a major problem if you don’t have a right to expand. This right can be secured at a set price for a set period for unused space in the building or project or by negotiating a right of first offer or a right of first refusal to operate when space in the building becomes vacant.
Tenants and landlords can negotiate options to give back space, generally at a pre-determined cost and usually after period of two to three years. Landlords are not too inclined to give these away but they act as a hedge against the market and for a short period of time help absorb common costs.
One more for good measure! If a tenant hasn’t negotiated an option to give back space, there is usually a specific right for the tenant to sublet some or most of the space.
Recourse to a professional commercial broker and a lawyer is critical to getting terms that work for you. Landlords prefer to impose limits or conditions on subletting. These limits include who you can sublease to (generally no one already in the building), the rent you charge the subtenant (i.e. not less than you pay and with any profit going to the landlord) and the business they operate (generally in line with the current use and not a competitor to any other tenant).
As always, to get the options you need or want, tenants and landlords are well advised to work with experienced commercial brokers and bring counsel in as soon as possible when negotiating offers to lease.
Patrick Murray practices in the business law and real estate groups concentrating in the areas of corporate law, financing, transactions and commercial real estate matters at McMillan LLP. He can be reached at 613-691-6118 or firstname.lastname@example.org.