The Lessor’s Choice: To Provide, or Not to Provide, an Option to Renew?

Posted on Oct 16, 2016   |   Categories: Commercial & Business Law, Commercial & Retailing Leasing

The question of whether or not to offer an option period on a Lease is often underestimated by Lessors during the negotiation of a new Lease.

Many Lessors consider the decision on the basis of “How long do I want this property rented for?” when, in reality, the question should be “Is providing an option term in my best interests as the property owner?

Often referred to simply as the Lease ‘option’, the ‘option to renew’ gives the Lessee the choice as to whether to take-up a further Lease at the conclusion of the initial term. Lessors must remember that the ‘option’ to take up the further term of the Lease is solely at the Lessee’s discretion, and so long as the Lessee has complied with all of their obligations during the initial term, a Lessor has no control over whether the option is exercised.

During Lease negotiations, a Lessor needs to consider the benefits and disadvantages of offering one or more option terms to the Lessee. Such a process of assessment is highly individualistic and requires personal consideration of the relationship with the Lessee, market conditions and future intentions for the property (including potential sale or personal occupation). This is a crucial decision because it directly affects the Lessor’s interests and investment.

The potential to capture a long-term income stream by including option terms can appear to be highly appealing for Lessors, and is often one of the greatest incentives that Lessees highlight during negotiations to enhance their own bargaining power.

It is true to say that for many Lessors, securing a tenant for a longer period is highly appealing; however, because the decision whether to exercise the option is at the Lessee’s discretion, an option period simply cannot guarantee any certainty of a longer tenancy. Of course, if the Lessor’s central focus is to secure a longer-term Lease, one or more option periods may achieve that objective. However, such an objective is far more effectively achieved by offering one single, longer term, with either one shorter option, or no options at all. A longer initial term of a Lease provides more real returns than any shorter term Lease with a long, or multiple options.

If the Lease does not include an option to renew, the Lessor may find itself in a stronger bargaining position because, if the Lessee truly wants to stay in the premises, it must renegotiate all terms of any future Lease. There are no obligations placed upon the Lessor to provide terms similar to those of the previous Lease. This creates a substantial shift in the power balance, in that the Lessor has greater freedom with regard to the future of its premises e.g. it may choose to sell the property, to transfer its ownership to a self-managed superannuation fund, find a different Lessee for the premises, on different terms.

With no obligation to enter into a further term with the Lessee, and the freedom to commence a fresh round of negotiations, Lessors become empowered to review acting in their own best interests. The ability to reassess whether commercial relations with the Lessee should be continued, should not be underestimated as a benefit of not providing an option period. It is often overlooked that in entering into a Lease, many Lessors have very little information about a Lessee such as – will the Lessee be different to deal with or what sort of tenant will the Lessee be? If there is no obligation to enter into a further term with the Lessee, some of that pressure is removed from the Lessor during initial negotiations.

With all of the relevant considerations for option periods being highly individualised for each Lessor, tailored legal advice and assistance in entering into a Lease is critical to ensuring that the decision to provide an option term or not is an informed choice. The decision should be made in the interest of obtaining the best advantage for the individual Lessor.

If you are in the process of determining the terms of a new Lease of your property, the experienced Property Law team at Baker Love lawyers can provide personalised advice to assist you in making the right decision for your commercial goals and interests.