Understanding how and when to exercise an option makes all the difference. Let’s dive into the details and learn why we generally advise our clients against exercising them in a tenant's market (like we're in now).
An option to renew is a clause in a commercial lease that grants the tenant the right to extend the lease for an additional term, typically under the same conditions as the existing agreement but with a varied rental rate.
For example, in a 5-year lease with a 5-year option to renew, the tenant can continue occupying the premises for an additional five years after the initial lease term expires (provided they give the landlord timely written notice within the notification period).
Here's the process:
Seems simple enough. But did you know that tenants usually have to enter into a binding agreement to exercise their option before knowing what the new rent will be?
If you agree to the landlord's proposed figure, it is taken as the new rental amount. And, if you contest, then you and the landlord must negotiate until you reach an agreement. Once all parties agree, the amount is deemed to be the current market rent.
If the parties cannot agree, most leases allow a valuer to be appointed to determine the market rent independently. This can be a timely and costly exercise that both parties will want to avoid. It might also not work out favourably for the tenant.
In most cases, if the opportunity to exercise your option slips by, the option will lapse unless your landlord consents to an extension or your in ongoing negotiations.
In this case, your landlord has the right to lease the space to someone else when your lease expires, which could mean uprooting your business and potentially causing significant disruptions.
So, if exercising your option is commercially best for your business because of strong ties to the location or a bespoke fit-out, it's essential to mark down option dates and set reminders to ensure you don't miss your opportunity.
Your lease agreement will outline the option notification period, which typically falls anywhere between 12-6 months prior to your lease expiry date.
In a tenant's market, it’s important to remember that you can quickly pay more than you should for your next lease term by exercising your option. Here are five tips to secure the best deal:
This is our number one tip for commercial tenants.
While option periods are a great safety net, they’re not always the best choice in a tenant’s market. Here’s why:
So, look to renegotiate your lease in advance of your option date. Use your encroaching exercise date as leverage and keep it in your back pocket if negotiations fall short.
Tenant tip: Remember that one of a landlord's biggest expenses is a vacant asset. So, when entering renegotiations, ensure the landlord considers your offer in the context of what would offer a new tenant and what it would cost them if you were to vacate.
Want to know a secret? The only thing that a landlord's real estate agent cares about is getting the deal done. They do not care about market review clauses that come into play in 3-5 years time.
Landlords tend to favour 'face' market rent reviews, while we (tenant reps) advise our clients to negotiate 'effective' reviews.
If you define whether the market rent review will be a 'face' or 'effective' review before you sign your lease, then you can control whether a market incentive is applicable if you choose to exercise your option. Depending on the market, the difference could be substantial over your lease term!
P.s: You can learn more about the difference between 'face' and 'effective' market rent reviews here.
If a landlord thinks that they have the upper hand at the negotiating table, they will propose an excessively high rent. That is because they know tenants do not have the same level of negotiating experience and market knowledge to bring the proposed figure down to a reasonable level.
Alternatively, if the market is relatively 'flat', the landlord may propose what seems like a relatively small increase – say 4-5% – in the hope that the tenant will not see the value or have the time for a rental dispute.
So if you intend to exercise your option to renew, speak to a tenant rep from the outset, long before your notification cut-off date. Tenant Reps know the market, and landlords know this. So, their strategy will be different.
A "variation of lease" or "variance of option" refers to making changes to the terms and conditions of a lease when a tenant exercises their option to renew. Instead of simply accepting the option as it is, tenants can use this opportunity to modify specific lease terms to better align with their business needs or preferences.
If you choose this path over renewal, be sure to start the process early (at least a few months before your exercise date). Here are the steps:
Remember that securing a variation of lease is a negotiation process. So, it's essential to approach it professionally, with a clear understanding of your objectives and a willingness to compromise with your landlord.
By simply exercising their option to renew, tenants can easily pay 20% more than they should for their next lease term.
The good news is that engaging a tenant rep ahead of an option deadline will significantly strengthen your position and lead to better outcomes.
At Tenant CS, we’re a team of skilled negotiators who understand the market inside and out. We handle your lease negotiations from start to finish, maximising your bargaining power and structuring the deal to suit your business.
Book a call with us today to see how we can help you.
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We acknowledge the Traditional Custodians of the lands on which we work. Our offices are located on the land of the Gadigal peoples of the Eora Nation and the Wurundjeri peoples of the Kulin Nation. We acknowledge their continued connection and contribution to land, water and community, and pay our respects to Elders past and present.
We’re proud to be an inclusive workplace, where diversity in all its forms are valued and every member of our team is encouraged to bring their whole self to work.
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