When negotiating a lease for a commercial purpose – whether it is retail, office or industrial space – the tenant’s hope and expectation is that its business endeavors will be successful and that it will be able to continue its business in the ordinary course. The tenant certainly does not wish to find itself in a situation where, at the expiration of its initial lease term – most commonly five years – the Landlord will not negotiate an extension of the Tenant’s lease term on reasonable terms. There may be a variety of reasons for the Landlord’s refusal to do so, including (i) the Landlord has a different tenant it wishes to occupy the tenant’s premises; (ii) the Landlord wants to change the “look and feel” of the plaza or building in which the tenant’s premises are located; or (iii) most commonly, the landlord understands that the premises are an important part of the tenant’s business, having to move operations is disruptive and expensive and in order to ensure continuity and minimize disruptions, the tenant may simply agree to pay a higher rental rate to stay in the premises.
This only becomes an issue when demand for rental premises is high in the area where the premises are located – if there is no other demand for the premises, the landlord will generally be happy to extend the tenant’s lease term on reasonable terms simply to have a tenant in the premises. However, the parties cannot know what the rental market will be like in the future.
The best way the tenant can protect itself from having to involuntarily move at the end of its initial lease term or from having to pay an inordinately high rent to stay in the premises is – as part of the lease negotiations for the initial term – to negotiate a right for the tenant, at its sole option, to extend the term of the lease at the expiration of the initial term, for an additional term (or an additional two or three terms) of a certain number of years. This option to extend should be included in the tenant’s lease to ensure it is binding on the parties.
While most landlords are agreeable to giving the tenant an option to extend the term of the lease, most landlords are unlikely to agree to a specific rental rate for the extension term, simply because it is difficult to know what rent the landlord would be able to charge for the premises at the later time. The Tenant should nonetheless ensure that that the rental rate for the extension term is agreed to be the fair market rental rate for comparable premises in comparable neighbourhoods in comparable cities for comparable uses. Landlords often try to include language that rent for the extended term will be the fair market rent for “similarly improved premises”. This is fine if the tenant has not made, and does not intend to make, any leasehold improvements in the premises. However, if the tenant has spent its own money in improving the look and quality of the premises, the landlord should not have the right to charge the tenant higher rent for the premises than it would have charged if the tenant did not make those improvements.
Language in the lease dealing with the option to extend should include a mechanism for the determination of rent for the extended term in the event that the landlord and tenant cannot agree on a rate – generally arbitration. The lease should also state that if rent has not been determined at the commencement of the extension term, the tenant will continue to pay rent at the rate it was paying immediately preceding the extension term until the rental rate is finally determined, at which time any amounts owing for any period of the extension term that has already passed will be retroactively paid.
When granting the tenant an option to the extend the term, landlords generally require that the extension term be on all the same terms and conditions as the existing lease save and except for rent which is to be determined. If possible, the tenant should attempt to negotiate a period of free rent or, if the initial term is lengthy – for example, 10 years or greater – a tenant improvement allowance to update the premises during the extension term.
Tenants should be wary of landlords agreeing to grant an option to extend provided that the tenant enter into the landlord’s “then standard form” of lease. This will allow the landlord to change the terms of the tenancy for the extension period without the tenant having the benefit of negotiating the form of lease. After all, the tenant has spent time, money and effort in reviewing and negotiating the terms of its initial lease. The same agreed upon terms and conditions should apply to the duration of the tenancy – whether it is for five years, ten years or longer.
For a discussion of additional items relating to commercial leasing from a tenant’s perspective, please click here.
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