Options in a Commercial Real Estate Lease

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By definition - an option is a right contained within a commercial lease which allows you to do something as the occupant. Generally, an option enables you to extend the term of your lease, cancel your lease, or purchase the building. Simple! Oh, I wish that were the case. In practice - option language and exercise can be much more complex. Let’s explore a few of the tastier ones - shall we?

Options are personal. If your company has successfully negotiated an option with the owner of your business address - the option is “personal” to only you as the occupant. It cannot be assigned. Consequently, if you’ve a right to buy the building at a number dramatically below market today - prohibited is passing this along to someone else. We’ve seen cases whereby an occupant exercises their purchase right only to quickly flip the property to another. However, there are tax consequences and logistical challenges to this approach. I should also mention - options completely benefit an occupant. An owner derives little if any benefit from their grant.

Strike prices. On the scale of most valuable to least valuable - an option right with a set price is the most attractive. Conversely, an extension with a price at “market” would be a bit better than worthless. A “market” option - an extension which computes the lease rate or sales price at the time of option exercise - is fraught with peril. Unless a specific mechanism is outlined to calculate market rates - left to opinion is the price. Here’s the rub. Let’s say you have a right to to extend your lease for five years at the prevailing market rates. Cool. You signed your lease in 2015. It’s time. But there is a problem. You and your landlord have a different view of the market and reach an impasse. Now what?

Time frames. Typically - an option - whether to extend, purchase or cancel will have clearly defined time frames from which your right may be exercised. IE: no sooner than twelve months or longer than six months before the expiration of your lease term. These periods are sacrosanct! Strict adherence must be observed or your right may be extinguished. So, what happens if you blink and miss the window? Should you start looking for a place to move? Not necessarily. You’ve simply limited your leverage as now you have no “right” to extend. Your owner still may want to keep you in residence - but at terms more favorable to him.

Method of exercise. Options must be exercised in writing by you. Remember that “options are personal” description? Yes. YOU must send a letter to your owner - unless another method - electronic exercise - is specified in your lease agreement. I discussed this issue with a prospect the other day who shared with me a horror story. Let’s call him Al. At Al’s prior location - Al wanted to renew his lease, avoid a costly move, and had an option to do so. Al’s owner paid Al a visit to discuss Al’s intentions. Clearly stated was Al’s desire to stay. Al assumed all was groovy. After all, Al made his pitch directly to the owner. In person! Imagine Al’s surprise when his notice to vacate arrived in the mail a few weeks later. You see, the option was not exercised in writing. Extreme? Maybe. But don’t fall victim.

  

Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.blogspot.com.