The renewal option in a lease is often misunderstood by even the most saavy business owners. In fact, many office tenants believe their renewal option is almost an extension of their actual lease. I can’t tell you how many times a prospect has told me they have a 10 year lease… well, 5 years with a 5 year option. Renewal options are a critical deal point for a tenant but it is important to understand the purpose and how they work.
Many tenants believe that their renewal option gives them the option to renew their lease for a set period of time at a pre-determined rental rate. In the office world, that is extremely rare, especially in this hot market. Most renewal options stipulate “fair market value,” but what does that mean?
“Fair Market Value” determined by who?
What factors determine “Fair Market Value?”
If not negotiated or understood properly, a renewal option can get a tenant into trouble. As a tenant, in most cases, you want the renewal option to be as flexible as possible. Ie, if you and the Landlord cannot come to an agreement of “Fair Market Value,” you have the ability to rescind exercising the renewal option. If you get to the final terms of the deal and you are unhappy with those terms but have no ability to rescind, you do not want to be contractually obligated to renew.
Additionally, make sure your broker carefully reviews the factors a Landlord will use to determine that “FMV.” Have they inserted language that says the rental rate will in no circumstances be less than the final year of the initial lease? Have they put a cap on the amount of Tenant Improvement dollars they will offer?
A renewal option is particularly useful in a very tight market. If you are in jeopardy of losing your space to another tenant or expanding company in your building, a renewal option can help you secure the space.
There are many other factors which must be taken into consideration. I have found that oftentimes, this clause is neglected in lease negotiations. It is important to work with a tenant representative who will carefully negotiate this deal point on your behalf.