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Know Your Options When Leasing Office Space

The extension, lease termination, and right-of-first-refusal options are powerful tools for tenants of office space.

Q2 2016
Commercial office space leases tend to favor the landlord. Lease terms, however, are negotiable. Tenants can and should add a few options into the lease language to create a more flexible, pro-tenant contract. Three commonly neglected opportunities in the lease negotiation are (1) the extension option, (2) the termination option, and (3) the right of first refusal. Tenants should push to add these options to the lease. Doing so allows tenants greater flexibility to adapt to business changes and the real estate market.

The Extension Option
When negotiating the lease, tenants should document in the lease their right to renew. In tight markets favoring landlords, a well-negotiated office lease extension option can serve as a ceiling on rent for the new lease term. The office lease extension option should also preserve the tenant’s rights and prevent the landlord from leasing the space to a larger or higher-paying tenant.

When negotiating the lease, tenants should document in the lease their right to renew. When negotiating your office lease extension option, consider the following items:
  • How many extension options do you have? Can you exercise them at the same time?
  • Does the extension option place a ceiling on the potential rent increase?
  • How long is each extension period? Are the lengths fixed or can you choose from different alternatives when you exercise the option?
  • Is the “notice period” appropriate and realistic?
  • Is your landlord required to remind you about the option to extend the office lease if you haven’t provided notice by a certain date?
  • Does the office lease extension option include a requirement for the landlord to provide an allowance for maintenance or repair when you exercise your option to renew? If so, and you decide you don’t need to use the allowance for maintenance or repairs, can you use it instead as a credit against future rent due?
  • How will rent be determined under the renewed lease if you exercise the renewal option (i.e., does it say rent will be calculated as the lesser of a percentage of the then-prevailing ?market rate? or a certain dollar amount per rentable square foot?)
  • Does the extension option include provisions for you to choose to expand your space? If so, will you receive a “free rent” period while you design and build out the additional space? (Make sure the option to extend will allow you to extend any expanded space in the future.)
  • How is market rate rent determined? (It should be tied to transactions for similar spaces by new tenants, and those transactions used should be for tenants with comparable creditworthiness, in similar spaces in similar buildings, with similar lease terms.)
When you provide notice of intent to exercise the renewal provision, the lease should require the landlord to provide you with a “good faith” estimate of its determination of market rate within a specified time period. The provision should further provide protection for you in the event that you and your landlord are unable to come to agreement on the market rate in a specified time period, including taking the matter to mediation or arbitration with neutral arbitrators, or allowing you to rescind your decision to exercise the renewal option.

Your option to extend the lease should be structured so that you will retain the option as long as you continue to lease a certain percentage of the original space, regardless of whether you have subletted or assigned a portion of your office space. The lease should provide that you have the option to extend as long as there are no material tenant defaults continuing beyond the notice periods and any grace periods.

The Lease Termination Option
Business is unpredictable, and sometimes an office becomes too expensive or obsolete. Tenants should protect against this possibility with a lease termination option. A lease termination option allows the tenant to exit the contract early, paying whatever amount specified in the lease. Tenants usually have to pay most of the remaining rent due to exit the contract.

A lease termination option allows the tenant to exit the contract early, paying whatever amount specified in the lease. When drafting a lease termination option, consider the following items:
  • Point(s) of termination: Are you comfortable with a one-time termination date or would you prefer to have multiple points that can be exercised at different times?
  • Prior notice: How much time prior to lease termination do you have to give the landlord? When negotiating think in terms of how fast would you need to get out if the worst-case scenario happened.
  • Lease termination fees: You probably won’t be able to negotiate an office lease termination option without fees, so the goal should be minimizing them as much as possible. Also, be sure to look up the state laws about termination fees so you are not locked into ones you normally wouldn’t be required to pay. Try negotiating for credits for things such as improvements to the facility and at what rate those improvements will be valued. When will the fees be due? Upon the termination date or after assessing the property?
  • Discount after office lease termination: If receiving a discount for a certain length of lease, be sure to negotiate how that discount will be handled during termination. Some lessors may try to charge an additional fee to recoup the discount.
  • Office floor plan: If leasing a location that does not require a specialized build/renovation, see if you can negotiate lower fees since the space should be easier to lease in the future.
  • Additional credits: Try to negotiate additional credits for items such as prepaid utilities or other location-based services.
The Right of First Refusal
Often referred to as the ROFR, the right-of-first-refusal option is a powerful tool for tenants. A right-of-first-refusal option gives the tenant the right to lease additional specified space should an outside party express interest in that space. The right of first refusal is often preferred to the right of first offer (ROFO). The ROFO gives the tenant the opportunity to lease a space before the space is marketed. The ROFR allows the tenant to wait until an offer from an interested party is in and then match the highest offer. The ROFR discourages other parties from bidding on a space since the existing tenant can match their offer.

When negotiating the right of first refusal, consider the following items:
  • Is the ROFR a one-time option, or does it continue through the term of your lease?
  • What space(s) does the ROFR pertain to?
  • When must the landlord notify you of a third-party offer?
  • After receiving notice from your landlord, how long do you have to exercise your option?
  • If you choose not exercise your ROFR option, will the third party’s renewal right override your ROFR?
  • If you exercise your ROFR option, will your extension option in existing space apply to the new space?
Remember, the time spent negotiating now is money you won’t have to spend later. Businesses should retain a tenant representation commercial real estate broker to negotiate the extension option, the lease termination option, and the right of first refusal. A tenant representation broker guides the tenant through the office relocation or lease renegotiation process. Specifically, the tenant rep broker helps office users define space requirements, identify potential locations, tour and evaluate properties, analyze proposals, negotiate terms, and execute the lease or purchase agreement.
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