What is a Commercial Lease Renewal Agreement?
A commercial lease renewal agreement is a legally binding document that sets out the terms and conditions for extending the duration of an existing commercial lease. Typically prepared well in advance of the expiration date of the current lease, a renewal agreement outlines the details under which the tenant and landlord agree to continue their contractual relationship, such as the proposed length of time the tenant will be allowed to occupy the premises, changes in rent, renewal fees, changes or limitations on the allowable use of the premises, and any other relevant terms not addressed in the original lease.
The purpose of a commercial lease renewal agreement is to provide both parties with the opportunity to establish a new lease at the conclusion of the current lease term, allowing them the benefit of certainty and protection from any disruptions to their business. In some cases, a renewal agreement may be mandatory, depending on its terms and conditions. While a tenant has the right to decline the offer of renewal, the landlord may seek damages from the tenant for failure to renew , as determined by its implications for the landlord’s intended future use of the property.
Commercial lease renewal agreements are crucial for both tenants and landlords. For tenants, they can be an opportunity to renegotiate the terms of the lease. This may entail a lease extension at lower rates or the opportunity for renewal even if the tenant has violated another aspect of the lease. A renewal agreement can also be advantageous to landlords as it permits them to preserve their income stream even in the face of a poor economic climate. Furthermore, landlords may benefit by inserting a rent increase into the renewal agreement, allowing them to level out increased operating costs over time.
Commercial lease renewal agreements are commonly used when a tenant desires the opportunity to remain in possession of the premises as long as it successfully conducts its business. This is especially true if the marketplace is strongly affected by fluctuations in the local economy. In general, renewal provisions are more commonly found in commercial leases than in personal residential leases, and are usually longer and more complex as well.
Essential Elements of a Lease Renewal Agreement
A lease renewal agreement composed by an attorney for the tenant is an important document that comprises of the elements outlined in the original commercial lease agreement. The following are general elements of such an agreement: A commercial lease renewal agreement may have the same terms and conditions of the original lease agreement with the understanding that it does not cancel the original and the original is not wholly incorporated but just by reference for the period of the renewal. When a renewal is negotiated, rent adjustments, additional obligations or termination, etc., may be added. A request for lease renewal by the tenant should be sent well in advance so that the landlord has ample time to respond. If the request is for a substantial reduction in rental amount the landlord may take into account decreased maintenance costs based on the master lease agreement obligations. Many landlords are at times willing to negotiate terms with the tenant for renewal as they may value the periodic monthly rent, security, etc., versus looking for another tenant and having to begin the lease renewal process which could take six months or longer. If the tenant fails to ensure that there is a provision or clause in the lease or specific renewal language and they just move or fail to give notice, the tenant may become month to month or suffer the consequences associated with takeover and/or termination provisions. A lease may be terminated if the tenant does not sign the renewal at the end of the period. It is important that the tenant considers that it may be in their best interest to obtain assistance from a skilled attorney in negotiating the renewal for them and keep the attorney on standby during the renewal process.
Advantages of Renewing a Commercial Lease
The renewal of commercial leases has significant benefits for both landlords and tenants. In commercial leases, the landlord typically prefers long-term agreements that offer long-term tenants in its properties. Since such leases often tie the tenant in place for up to twenty years, the landlord can be confident that it will have breathing room in the market when reevaluating its portfolio. The ballpark estimate for the turnover rate in an investment property portfolio is roughly 10% per annum. Thus, tenants that stay in place for a longer tenure help the average landlord stay in the ballpark, as it were, bolstering the stability of the income stream.
The benefit for tenants is likewise straightforward: the renewal of a commercial lease offers you continue tenure in the commercial property. Another benefit for tenants is that tenure at a commercial property offers the ability to make infrastructure investments which benefit the company over the time of the lease. This is frequently seen in retail leases, where long-term tenants often install and upgrade fixtures in their premises in order to facilitate certain brand experiences. The value that the property owner may offer, in this case, is permission for the tenant to make those fixtures into the premises, which the tenant will later have as an asset even when the lease terminates.
Common Issues in Lease Renewals
Negotiation hurdles: Not all tenants are sophisticated enough to be able to understand the many issues that go into commercial leases and are therefore very dependent upon their real estate agents and lawyers to guide them in selecting their space. In some instances, the negotiations might take place in a very tight time frame as the landlord is looking at the new tenant’s lease as a basis for the new construction or build out of the space. However, if the parties are not able to agree on the terms of the renewal, it could lead to costly delays for either party while continuing to pay rent and taxes.
Lease term changes: If a tenant has been occupying the premises of an office building since the building opened then the rental rate charged to the tenant may be at the very low end of the rental rates in the market today. The tenant has likely paid the same rent for a number of years and is now looking to extend its tenancy for another 3 or 5 years. The challenge to the tenant is that its current rental rate is below the market or has now become grossed up for its additional share of operating costs and taxes. The challenge to the landlord is that it wants to increase the rent and possibly extend the existing options at a higher rate, but the current rate is at the low end of the market rental rates. The risk to the landlord if no agreement is reached is that the landlord may have to deal with vacancies in this tight market and in the event the landlord does find a new tenant, any loss of rental income and increased leasing costs for that space could take years to recover from.
Market Conditions: There are times when the market is conducive to leasing space and there are occasions where the market becomes so slow that landlords will be more flexible in their negotiations. Sometimes the landlord is not able to accommodate the ability of the tenant to expand within the building if the tenant is successful and needs additional space. This might also be a good time for the tenant to negotiate free rent and/or additional allowances for building improvements. The key is to act quickly as markets often turn very quickly.
Negotiating Terms of a Lease Renewal
Negotiating lease renewal terms is a lot like getting ready for a big game. You need to have prepared and practiced to put yourself in position to negotiate the best outcome possible. Before you can begin negotiating the terms of a possible renewal, it is in your best interest to prepare yourself.
Learning the local market rate is a simple way to know where you stand in the negotiations for a renewal. If you find out the current market rate is significantly less than what you currently pay, then you might want to negotiate to stay in your current premises at a new rate if your condition at the current premises is satisfactory.
There is no harm in asking if the landlord to waive its right of offset, which gives the tenant the chance to stop paying rent in the cases of default by the landlord. In the end, it is up to the landlord whether or not they want to waive the right of offset .
Also useful is learning the rental rate in locations nearby, in case a move is necessary. If the landlord will not negotiate, there may be other buildings nearby what you could move into that were built more recently, have better amenities, etc.
If your business is doing well and the properties in the area around you have a higher rental rate, there is an opportunity to take advantage of that and possibly get a break on your rent in the process. If the rental rates of the properties surrounding your current address are significantly more than what you currently pay and your business is booming, moving into one of those properties gives you a chance to capitalize on the marketplace as well as take advantage of your success.
The most important aspect of negotiating lease renewal terms is being fortified with information before you even meet to talk about the lease. The goal should be to come away from the meeting with a signed lease at or above current market rates.
Legal Aspects of Lease Renewals
When it is time to renew a commercial lease, there are several important legal considerations to keep in mind. It is always good practice to review the lease agreement terms to ensure that they adhere to current law. For instance, most commercial leases will be for a term of over one year. Under Indiana law, in order to be enforceable for longer than one year, the agreement must be in writing. Further, the terms of the agreement must be clear and unambiguous. Ambiguous terms could cause difficulties in the future and could ultimately result in an adverse ruling in the event of litigation. It is also important to make sure that each clause in the lease is consistent with current laws to avoid any potential for liability. For example, if the premises will not be suitable for the business use contemplated by the parties, even though the parties have agreed to it, it could be unenforceable for vagueness or because it is against public policy. Before signing a renewal of the lease, it is also a good idea to review each new provision to ensure that it is fair and in line with the market. For example, if the rent has increased, is it in line with market value? If the premises are older, are there any special assessments for repairs that are needed in the upcoming months/years? If so, and the parties are expecting the current tenant to still be in possession of the premises at that point in time, the lease should address how those assessments will be handled. Consideration should also be given to who advises the client on the new lease terms. It is usually a good idea to seek the advice of counsel familiar with commercial leases to ensure the best possible terms to protect the client’s interests.
How to Successfully Renew a Commercial Lease
An approach to the renewal of a commercial lease is somewhat similar to the approach adopted by a landlord in dealing with an early request for renewal. In both cases, a review needs to be undertaken of the terms of the existing lease so as to ascertain the terms from which a landlord has a right to benefit as compared to the terms which should be maintained, in particular those provisions which are solely for the tenant’s benefit.
Following in the same manner as with an early request for renewal, it is considered that a prudent landlord would need to focus on two main areas, namely:
The alternative approach, where an open market decision had been made by the landlord, is to review the terms of the new lease in the context of current market rent. Any rent review provisions beneath the heading of Current Rent are intended to be self-contained, and should be followed in the same manner as those set out in the previous section above in the context of an open market rent. Any market rent review provisions identified in the new lease which is more applicable to the existing lease would then be assessed so as to ascertain the effect that it would have on the overall terms of the new lease. In particular, the following items would require consideration:
In the case where the tenant has decided that they wish to submit a Section 26 Notice, then this should be drafted, served and a copy sent to a solicitor as soon as practicable.
The process would be similar to that set out in the previous section declaring an intention to renew, and include reference to any other documentation which is deemed appropriate in order to evidence the request for renewal.
Once the renewal process has been agreed in principle, a renewal of the lease should be prepared. Apart from the obvious details in respect of the parties to the lease and the date on which the new lease would be granted (which would usually follow on immediately after the expiration of the existing lease), there are a number of other clauses which are worthy of further review including:
Agreement would generally be reached on further discussion between the parties, together with the expenditure of good faith and any other documents which are required to give effect to the renewal of the lease. The renewed lease or formal licence to assign would be signed by the landlord and submitted to the tenant for execution, and upon the solicitors for each party meeting the request for renewal would correspond accordingly to declare that the lease has been formally renewed.
Options other than Commercial Lease Renewal
When it might not make sense to renew a lease: There are options that you do have that may be more attractive even if they can be more expensive in the short term. You can relocate or renegotiate your terms from scratch. You may even be able to do a lease buyout with your existing landlord if you want to relocate your business. While relocating is often incredibly inconvenient and expensive to do, renegotiating your terms from scratch and paying a lease buyout can be too. So the idea is that if you know that you have some leverage (e.g. you have at least three years left on your lease, your rent is below-market in the area, and more than two tenants in the area are ready to sign and extend their leases), it may be worthwhile to spend that money and time getting a better deal with your current landlord (the deal you deserve as it ultimately allows them to keep you as a tenant) . But if you know you don’t have the leverage, know that you have the ability to find a better deal elsewhere. Certainly, you can negotiate for a better deal at your current location. But if that doesn’t pan out there are other options. First, you could just move entirely. Find and negotiate a new deal in a new location and get out of your current lease. Or, you could negotiate to pay your current landlord to release you from your existing lease and walk away. That can be a great option if you have a very short period of time left on your lease term and you don’t expect to make up that cost in rent savings. Note also that this is something where you can leave a good impression on your landlord, which might open doors for you in the future. So keep all the above in mind, and be proactive so that your new lease and rent payments are exactly what they need to be and not a penny more.