If you’re not new to the business world, then you probably know that the commercial leases are long-term contracts signed for anywhere between 3 and 10 years. Once the initial lease has expired, most contracts include an extension option. The option is known as the renewal clause and it permits you to decide whether you should extend the initial leasing date, an element that real estate agents generally perceive as a benefit for the tenant. Most entrepreneurs will agree that the renewal option should not be your primary concern when signing a lease. However, even with its secondary role, the clause can have a big impact on your business in the long run. Let’s find out why your leasing contract should include it and how you can get the most out of negotiating your renewal option.
How is the renewal clause protecting you?
In spite of the popular belief, the renewal option provides little if any benefits for the landlords. In fact, the clause is designed to protect the tenants’ rights and confer them negotiation leverage in today’s market conditions. Common examples of situations when the renewal clause protects you include: • When another tenant is willing to pay a higher rate for the space you are currently occupying and paying for • When another tenant wants to expand and has set his eyes on your current space • When you have made huge financial investment in the current space Having a well-structured option acts like a framework that allows you to control further costs. Without denying that it’s in the landlords’ best interest to renew your contract, keep in mind that they want to achieve this goal in the best terms possible for them. This is why some tend to construct this clause relatively vaguely, so that tenants don’t want to go through the trouble of invoking the ideal framework. Even though your business is doing fine at the moment, don’t forget that there’s no way to predict the market conditions in 5 or 10 years from now. Therefore, if the renewal option is not well-structured from the very beginning, it may end up being very costly for you. Frankly, the safest approach is to always assume that the market condition will be in the landlord’s favour in the years to come.
Factors to account for when negotiating your renewal clause
Now that you understand the critical role of the renewal option, we hope it’s easy to see why landlords are generally reluctant towards including this clause in the contract. Then again, most landlords will grant the option because in the majority of cases it is a law-mandated element for sealing a lease. The renewal clause will typically feature the following elements that you should evaluate carefully: • Term As you probably guessed, the element refers to the period of time during which you can decide whether to renew the lease. In general, it’s best to have different length terms specified here, meaning 3/5 years or 7/10 years. • Rental rate Unless your renewal clause features a predetermined rental rate and specifies a sum, your new fees will be calculated in financial terms strictly linked to the fair market value. • Fair market value To avoid giving the upper hand to the landlord in a future negotiation, it’s highly advisable that the terms and data regarding the calculations of the fair market value leave very little to interpretation. • Notice period This element specifies the time you have to express your written intent of exercising your right to renew the leasing contract; this is usually 6 to 12 months prior to the expiration date.
Long-term versus short-term leasing contracts
If you were to browse through the guides on leasing contracts, you would be surprised to notice that most experts recommend opting for long-term leases that feature a well-structured renewal clause. Based on these authors, the reasons why short-term leases are an overall bad idea include: • Short-term leases don’t give you any negotiation leverage • Landlords are willing to fewer less concessions with short-term contracts • You won’t be able to make significant improvements while using the space • Any investment made in the space will come out of your pocket • Landlords are not motivated enough to allocate funds to improve the rented space • You will be unable to obtain better rental costs once you seal the deal • You are very likely to pay higher rental fees if you decide to renew the contract Granted, signing a short-term contract with the possibility of renewal based on a predetermined increase of the rates is a prudent strategy. However, this should not be the main criterion you base your decision on. Keep in mind that each business and industry has its own particularities, so there are good reasons why certain companies prefer long-term over short-term leases. Therefore, evaluate your company’s needs, conduct a risk analysis and determine what would work best in your current situation.