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Occasionally,
a long-term decision must be made in the midst of a short term disruption - our
present circumstances. If you lease commercial real estate and currently have
an option to renew your term or purchase your building - you understand what I
mean. You must predict where business will be in the future. An option is a
right you have as an occupant. Certain characteristics apply. For one thing -
an option is personal. Simply, you cannot transfer it. Dates are critical -
also known as “time is of the essence”. A fancy way of saying - if you don’t by
then you can’t. Finally, most options contain a mechanism for the exercise of
the right plus some means of determining price and terms.
Typical
language in an option to extend the term of your lease might be -
five years at the prevailing market rents for comparable buildings within your
market - but in no event less that your current rent. Ok. Easy enough.
Generally, you’ll have to notify your landlord in writing within a window of
time prior to the expiration of your lease. Common is, no sooner than nine
months or later than six months is common. Got it!
However,
here is where things get tricky. What if your window - to extend your term -
opened on April 1 of this year and closes June 30? Hmmm. A bit tough to imagine
where we are headed - especially if now you must commit for an additional five
years.
So
what should you do? I’d break it down like this.
Understand your specific option. You could
have something of real value here! Or, you might simply have an agreement to
agree. In the former, options forged during the last downturn could be at
preset rates. Those presets could be substantially below the prevailing lease
terms found in today’s environment. Value indeed! You can stay, avoid a costly
move, and enjoy a favorable rent. Conversely, your “market rate option” creates
a negotiation with the owner. Tenancy continues but at a higher amount.
Regardless, spend some time and know how your option reads.
Take a look at the worst-case scenario. What happens
if you don’t exercise your option? Will the landlord give you the boot? Certainly,
that is a possibility. But how realistic? Here is where you might be
vulnerable. Let’s say you moved into your space in 2010. Times were a bit
different then. You clipped along for five years and extended for another in
2015. Mid-decade found rents on the rise - but the exponential increase
occurred in 2017-2019. So now, a wide gap might exist between the rent you pay
and the market. As we explained above - if your extension is tied to current
rates vs presets - you’re facing a monthly bump. On your side? The cost to
replace you. Don’t forget. Vacancy down time, concessions, abated rent, and
brokerage fees - all must be paid by the landlord if you bolt.
Examine where you are - now. Congratulations!
We’ve just weathered one of the largest business downturns - if not the largest
- EVER! If you’re still standing - albeit a bit wobbly - chances are your
operation is built for the long pull. My prediction is we climb from here. Send
that letter! Stay and pay. On the flip side - serious concerns about the future
don’t bode well for long term commitments.
Talk to the owner of your building. With the understanding
of your specific option, a hard look at the worst case, and a view of present
and future - schedule some time to talk to your owner. It should be in person.
This can be challenging but manageable with ZOOM or other video conferencing
tools. Covered during your chat will be your view of the world, your desire to
renew or move, and an exchange regarding his situation. We just attended such a
meeting. It was enlightening! Resulting was a comfort level. Both sides aired
their positions. We will now move forward. However, some tenants use the
following strategy. The building works for our business. We’re girded and armed
for what’s next. Rent as outlined in the option is too high. What can we do?
Your landlord’s answer might surprise you.
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.