The Commercial Real Estate Lease

A Lessor’s Perspective on the Option to Renew

 The option to renew a lease in a commercial real estate contract provides the tenant the right to continue leasing the property for extended periods of time.  This promise of continued occupancy has continued for many centuries; however, a landlord has no obligation to grant an option to extend the lease for any period of time.

There are times when the option is good for the landlord.  Below are examples of when an owner should consider providing language to extend a commercial lease in a contract to the tenant:

1.    The economy is bad and there is a high vacancy rate resulting in a slow leasing market
2.    The tenant wants to make significant costly improvements to the building
3.    An highly credited national company who attracts major tenants to the area is the tenant
4.    A tenant paying top market rates and there are required “Fair Market Value” adjustments at certain time intervals

There are other times when an option to renew a commercial real estate lease is not appropriate for the owner.  Listed below are some reasons why the landlord should not grant options to a tenant:

1.    The landlord can’t recapture the premises in any short period of time, and the tenant controls the space
2.    The landlord intends to sell the property, and a long term lease may impact the purchase price.
3.    The tenant is creating a nuisance to other tenants by running an incompatible business
4.    The tenant may expose the property to environmental hazards
5.    The landlord is planning to redevelop the property; consequently, long term leases with options to renew may impede the new development
6.    A tenant may only occupy a small portion of the property and adjacent tenants may need to expand their space; as a result,  the landlord could retain the larger tenant for a longer term
7.    When prices are rising in the area and the contract option are far below a fair market value

Granting the option to renew a lease gives the tenant greater flexibility for long term planning.  However, not granting an option gives the landlord greater flexibility and protects the investment.  

My advice to the commercial real estate owner is to offer the tenant a short or long-term lease and not grant an option to renew.  For example, a tenant who requests a 3-year-lease with a 2-year-option should be advised by the landlord to take a 3 or 5-year-lease with no option to renew.  The tenant should always have the right to sublease the premises if necessary.

"Lee Segal was employed to assist our company in the acquisition of two industrial manufacturing facilities in Mexico.  I worked with him closely for several months, and I came to depend heavily on Lee for his technical knowledge and business acumen in commercial real estate.  He is absolutely my first choice as a consultant when I am faced with similar acquisitions.  In addition, he is the first person I recommend to colleagues and clients.Lee‘s capability and professionalism in commercial real estate matters make him the best addition anyone can have as a lead member of a critical team."
Sheldon Campbell, Corporate Facilities Manager, Compass Plastics Technology/AB Plastics; General Manager, Quality Laminates de Mexico, S.A. de C.V.