Options in commercial leases

Before you shoot me down for being in favour of having a long term commercial lease an owner should consider all aspects of what the option means, not just to you as the lessor but also from the tenant's point of view at well.

Many commercial and retail property owners offer options on their leases either to comply with retail leasing obligations or as a point of difference to their tenants (who are their customers).

Tenant's view

• Security of extended tenure
• Value of a specific location to the business (Eg landmark building/flagship site)
• familiarity/certainty

Owner's view

• Benefits of a longer term lease (financial benefit)
• Possibility of no vacancy and reduced expenses (no letting fees, no additional incentives, known tenant)
• Lower vacancy rate
• More saleable (ie long term tenant/lower risk - lower cap rate/higher sales price)
• Certainty of rent reviews at option (possibly)

Misconceptions

• Locked-in/no flexibility for owner

How do you work around these issues to your advantage/mutual benefit?

• Demolition clause (lessor)
• Relocation clause (lessor)
• Break clause (either party)

Each of the above types of break clauses have their application and conditions surrounding their use and need to be inserted into the lease when negotiating the deal at it can affect how the tenant views the lease.

A demolition clause is used where you foresee a need to redevelop the site at some point and will require vacant possession. This type of break requires that you have a DA/CC and are able to enter into a contract with a builder to undertake substantial works which will require the tenant to vacate.

A relocation clause is similar to a demolition clause however puts an onus on the owner to provide a suitable alternative premises within the same complex (usually for a shopping centre but can apply to an industrial or office building.

A break clause is a less specific break to the lease which is usually applicable to longer term leases or consecutive leases (where future leases exist but the tenant may out out). These clauses may have an expiry or a block out period before they can be invoked.

Having an option in a lease is not something to be afraid of but knowing how to construct a lease with adequate checks and balances to mitigate risk is just as important a factor to ensure that the option can work to your advantage too.

 

Very interesting points @Scott No Mates. Not to detract from your points I see very little reason to tack multiple options on leases (one is enough) the reasons are three fold.

1. Demolition/Relocation Clauses actually scare most tenants, any time I mention a Demo clause in negotiations tenants ask me what the owner is planning (normally this is 5+ years away and even the owner has no clue)

2. Selling business's: Whenever a business(leasehold) is sold I try to re-negotiate the lease, change CPI to fixed, update security deposits, increase lease term (i.e. 3 years to 5 years) and more generally create a "fresh lease" the best way to do this is by addiing an option for the new business owner.

3. The tenant is the one that gets to exercise the option and for this reason I usually view any property for sale were the tenant has options as not having them at all. But in saying that valuers and lenders love them.

So I used to work for a 2nd tier firm in Melb CBD and I always questioned why I was getting 3+3+3+3+3 leases from the leasing department. Honestly in most cases I think some people hand out options like hot cakes.

However to add to your points: One thing every option needs is a clearly defined "exercise period", the time the option can be taken up by the tenant.

 

Good point - I've seen anything from "at any time prior to 6 months before expiry" - usually on 3-5 year leases, between "6 & 3 months prior" for shorter leases or "not less than 12 months prior" for longer leases.

A good tight option clause can cause the tenant to miss the date and open up negotiations (can be good for both parties too).

 

Also notification of exercise of the option needs to be clearly defined.

There was a case a few years ago where a lessee claimed to have notified the lessor that they wished to exercise their option and renew the lease for another 5 years. They did this via an informal email to the lessor. This didn't conform to the requirements under the lease.

Lessor kicked them out and leased it to someone else. Multi-million dollar fit out had recently been done and they lost their business