If negotiated properly most office space leases have renewal options that give the tenant the right to extend the lease beyond the initial term. This is a benefit for a tenant and one that should always be incorporated if possible.
Having an office space lease renewal option gives you more control. Most landlords are reluctant to give you a renewal option because it limits the control they have on the space, however they realize it may be required in order to get the deal done.
Characteristics of the Renewal Option
Advanced Notice – Most office lease renewal options require that you give the landlord prior written notice of your intent to do so. This timeframe can be anywhere between 6 to 12 months before your lease expires. Ideally you want this timeframe to be long so you have enough time to evaluate the market and compare alternatives before making a decision.
Lease Term – The renewal option will be a specified lease term (typically 3-5 years). To retain flexibility you would want to ask for a renewal lease term of a range of years (e.g. 3-5 years).
Rental Rate – Most landlords won't want to commit to a rental rate that far in advance so they will typically use “Fair Market Value” (FMV). In other cases there may be a predetermined rate.
- What is Fair Market Value? – This consist of a landlord’s good faith determination of the annual amount of rental that a willing tenant would pay, and a willing landlord would accept, bona fide negotiation for a renewal or expansion lease of the Premises to be executed and to commence on the commencement of the Extension Term, based upon other lease transactions made in the Building and other comparable office buildings in the Austin Central Business district submarkets, taking into consideration all relevant terms and conditions of any comparable leasing transactions, including, without limitation: (i) location, quality and age of the building; (ii) use and size of the space in question; (iii) location and/or floor level within the building; (iv) extent of leasehold improvement allowances (considering existing improvements); (v) the amount of any abatement of rental or other charges; (vi) parking charges or inclusion of same in rental; (vii) lease takeovers/assumptions; (viii) relocation allowances; (ix) refurbishment and repainting allowances; (x) any and all other concessions or inducements; (xi) distinction between “gross” and “net” lease; (xii) extent of services provided or to be provided; (xiii) base year or dollar amount for escalation purposes (both operating costs and ad valorem/real estate taxes); (xiv) credit standing and financial stature of the tenant or subtenant; (xv) any other adjustments (including by way of indexes) to base rental; and (xvi) length of term. The best comparable for determining the Extension Term Rent shall be similar leases that Landlord has executed or will be executing in the Building.
- What if you do not agree with the proposed rental rate? – If you negotiated to have this during your initial lease negotiation you may have the ability to use an arbitration procedure. What that means is If, after review of Landlord’s determination of the Extension Term Rent, You object to Landlord’s determination of the Extension Term Rent, then it can proceed with some sort of arbitration procedure that was previously agreed to. This can be set up different ways however the most common is for the landlord and tenant to each find an unbiased third party (e.g. commercial brokers) that tells them what the rental rate should be. The average of those two numbers becomes the rental rate.
Renewal Options are not typically assignable – Unless you negotiate differently beforehand office space lease renewal options are always personal to the tenant (you) and may not be assigned to anyone else. It may not be exercised by any assignee or subtenant of Tenant
Office Lease Renewal Options Give you More Protection
Renewal options do not provide the landlord any benefits at all. It's a tenant benefit and gives you more control during negotiations when the markets are more in favor of landlords. It can give you more protection if:
- Other tenants may be willing to pay more for your space
- Another tenant in the building may be interested in taking your space
- You have a lot of financial investment (e.g. tenant improvements) in the space and do not want to be forced to relocate
It's hard to predict what market conditions or your business needs will be 5-10 years from now however by having an office lease renewal option you will be better protection and control of your space