The time for renewing a lease a great opportunity for tenants to evaluate his/her present day position as a tenant; re-examine the current commercial real estate market; use that information to negotiate the best lease terms.
Those who position themselves as well-informed tenants with a better understanding of their leasing options usually secure much better deals than their uninformed counterparts. Here are some helpful tips that can help a tenant negotiate a better commercial lease renewal:
- The very basics
- Time frame to exercise your option
- Renewing your lease without an option
- How your rent will be reviewed for the new term
- Don’t exercise the option ‘Subject to’ anything
- Know the current market
- Be a ‘good’ tenant
Understanding Basic Lease Renewal Methods
It is important to understand that there are two common ways to approach lease renewals.
The first method is simply by ‘exercising an option’ and the other common method is by simply negotiating a new term. For more information, you can read our article on commercial leasing options.
Time Frames For Renewing Your Commercial Lease
Most commonly, your lease will give you a window of three (3) months in which to exercise (i.e. take up) your option term. The majority of leases will state that this window opens six (6) months prior to your lease expiry date and it closes three (3) months prior to your expiry date.
This means that you should mark your calendar at lease six (6) months out from when your current lease term expires, so you can exercise your option with the owner/agent. Some lease are written differently, where you have to provide a longer notice period, so you should always check the specific provisions of your lease to be sure.
The applicable time frame / dates can be found in the schedule of the lease (usually near the front of the lease, though sometimes at the back) showing you what the conditions are for when you can exercise the option.
If you miss the deadline, you can still negotiate a new lease with the owner / agent, but if agreeable terms are not reached, then you may have to vacate the property.
If you want to protect your business and make sure you are given the next term of the lease (option), then make sure you exercise it in the right time frame.
Renewing Your Lease Without An Option
This is common practice in commercial leasing. Even if you negotiated an option, or multiple options, when you first leased the premises, at some stage you will come to the last option term and will have no further ‘option’ to renew.
You may have even negotiated your lease in the first place with no option terms to allow you to extend the lease, so in either of these instances, you will need to rely on negotiations with the landlord (or their agent) to secure a new lease.
You may have also simply overlooked the time frame to exercise your option and now need to negotiate new terms with the owner (or agent).
The earlier you can start negotiating new lease terms with the owner (or agent), the better. Bear in mind that under commercial leases (unless otherwise negotiated) either party can terminate the lease with a month’s notice in writing to the other party (so long as the expiry of that notice would not be earlier than the expiry date of the lease).
As such, if you cannot reach agreeable terms, you could be given as little as a month’s notice to vacate the premises, which could cause considerable stress and disruption to you and your business. If you are negotiating with a few months up your sleeve (i.e. a few months before your lease is due to expire) and you find you cannot reach agreeable terms, at least you would have until the end of your lease to relocate (plus any leniency / extra time you may negotiate).
If you have negotiated agreeable terms months in advance of your lease expiring, this should at least allow ample time for the new lease to be prepared, reviewed and executed, which should ensure you have reliable continuity of tenure in the premises.
Common terms being negotiated in these situations include what the commencing rent will be for the new term, what the length of time / duration will be for the new lease, if any options will be granted and, if so, for what terms. You may also negotiate items such as the annual rent increases to be applied and whether any works are to be done by either party in consideration of the new lease.
How Your Rent Will Be Reviewed For The New Term
If you are exercising an option to renew, the most common rent review method is a ‘Market Review’. This is not always the case, however, so you should review the schedule in your lease that sets out the type of increase that will be applied. It is not uncommon for this to be a fixed percentage increase or even a simple CPI increase. If in doubt, consult your lease for the answer. In this section, we will talk about the market review, as it’s the most common form of rent review performed at an exercise of option.
The market review will generally be conducted by the agent acting for the Lessor (owner) and it effectively determines “what is the reasonable rent we would expect to achieve for the premises if it was marketed and available to lease at the current time (in the current market)”.
This method serves as a ‘fairness’ test for both parties to the lease. A rent that is under market is unfair to the owner, and a rent that is over market is unfair to the tenant. A market rent is no more and no less than either party would expect to pay or receive if they were dealing with another party ‘in the market’.
To determine a market rent, an agent should be analysing multiple comparable leasing transactions in the market to determine what ‘rate’ is being achieved ‘in the market’ for comparable properties. This rate can by analysed and then applied against the subject premises to calculate the market rent. As an example, let’s say that you are leasing a 200sqm industrial unit in West Gosford and you are paying $21,400 per annum net + GST, which equates to $107 per sqm + GST, but the latest leases have been negotiated at $115 per sqm + GST. Using this information, we could calculate that the market rent for your property would be $23,000 per annum net + GST ($115 per sqm + GST x 200sqm).
Once the ‘market review’ has been conducted, the owner (or agent) should serve you with notice as to their determination of what the current market rent is for the new term.
If you believe the rent review is not in line with market, the lease should provide you with a mechanism to dispute the findings. Usually you can have an independent licensed valuer appointed to conduct their own independent market review.
In most leases, the cost of this valuer will be borne by the party who is incorrect in their assessment (i.e. if the valuer agrees with the market review figure given by the owner, then the tenant would have to pay the cost of the valuer, or if the valuer agrees with the figures given by the tenant, then the owner would have to pay the valuer’s cost), or if the outcome is a compromise between the figures, then the parties generally share the cost of the valuation.
Our best tip, if you believe the rent given from the ‘market review’ is incorrect, you should propose a counter-figure and supply supporting evidence to demonstrate how you have arrived at your alternative rent.
It is always best if an amicable outcome can be reached between the parties without the need to engage external parties (such as a valuer), given the potential costs involved. Naturally, if a compromise is found, both parties are likely to be more content with that result than if the result needs to be determined by a third party at a cost.
Don’t Exercise ‘Subject To’ Anything
We often have tenants write to us to exercise their option subject to some condition (commonly subject to what the new rent will be, or subject to a further option being given, or subject to some works or upgrade being completed, or any other number of things).
If you exercise your option ‘subject to’ a condition, then you have NOT exercised your option. A valid exercise of option (i.e. one you can rely on) is a very simple, straight forward ‘exercise of the option term, pursuant to the terms and conditions of the lease’.
If you do exercise your option subject to a condition, then the owner (or their agent) may be within their rights to reject the exercise of option, as it has not been done in a way that complies with the conditions of the lease. If you need to rely on the exercise of option to keep your business trading from the premises, then it’s not worth taking the risk of a ‘subject to’ exercise of option. Keep it simple!
A lot of people don’t want to take up their option without knowing exactly what the rent will be for the new term, which is why we commonly see tenants trying to exercise their option ‘subject to what the new rent will be’.
To give you some help in this area, we will give you a couple of tips later in this blog.
Know The Commercial Property Market
This may seem fairly obvious, but the best thing you can do is to educate yourself as to the segment of the commercial property market that your property it is in, be it commercial, retail or industrial.
Knowing the market will tell you things like:
- What other options are available, should you need to move
- What comparable properties are being rented for
- What incentives are available in the market
- What demand there is from tenants to lease premises similar to yours
- How much lead time you may need if you need to relocate
Being prepared is always a great advantage in business. Keeping your finger on the pulse is a great way to stay prepared.
This should be useful whether you are taking up an option and want to know that the ‘market review’ conducted by the owner (or agent) is in line with the market, or if you need to negotiate a completely new lease for the same premises, or if you need to relocate.
Knowledge can be powerful, so make sure you arm yourself.
Be A Good Tenant
Again, this may seem obvious, but it is probably the most important tip we can give you and it covers a multitude of things.
Being ‘on time’ with your rent, for example, will not only keep you on good terms with the owner, but it is essential if you want to exercise your option term.
Almost all leases will state that if you are in breach of the conditions of your lease (such as by having rent overdue), then the owner does not have to accept your exercise of option.
Keeping a good relationship with the owner is, in most cases, a sure way to make life easy for yourself when leasing a property.
If you have good ‘housekeeping’ practices and keep the property in good order, an astute owner will notice. A less astute owner may not notice.
If you have poor ‘housekeeping’ practises though, any owner will notice, as this will create issues with risk / liability at the property, which will impact the owner’s property insurance, not to mention the potential complaints it may generate from adjoining tenants / occupants, which is sure to upset your owner, too.
Taking care of the property can be more than just good housekeeping though. If there is damage or a problem with the property that is your responsibility, action it promptly to keep the property in good condition. Ideally, report this to the owner (or their agent) so they know what has happened (they can see you’re being transparent, not hiding anything) and they know that you have actioned it already. If the responsibility for the repair lies with the owner, report it to them promptly so they have the opportunity to attend to the repairs / works (they can’t repair what they don’t know about).
If you know that you will not be renewing your lease, give your owner (or agent) as much notice as possible. This allows them time to start marketing the premises and to work with you for any special arrangements for access to the property for inspections etc. It will also keep your relationship ending on a good note with the owner (or agent) as you’ve tried to ‘help’ them by providing more than the minimum notice required.
Being a good tenant will also get you a great reference from the owner (or agent), so if you do have to move to a new premises, a new owner is more likely to accept you as a tenant, knowing that a previous commercial property owner has had a great experience with you. This helps to limit the threat of an unknown risk to them when they are leasing their property to a new tenant and it may help to secure you more favourable lease terms.
For a full list of everything commercial landlords look for in a tenant, you can read our article on how to spot bad tenants.
Interested in reading more? Check out our other blogs.