Negotiating Renewal-Option Clauses and How Best to Exercise Them For Medical Office Tenants

Dale and Jeff - Back to BackBy Dale Willerton and Jeff Grandfield

The renewal-option clause in a lease is there for the sole benefit of the tenant. Essentially, its purpose is to ensure that you’re allowed to lease your space for another term, as long as you meet the predetermined conditions in the lease agreement. Not all landlords automatically include renewal-option periods or terms in their offer to lease or formal lease agreement. As a medical office tenant, it is your responsibility to request, insist on, or negotiate for renewal-option rights. In some cases, there will actually be multiple renewal-option terms running consecutively,

While the lease-renewal clause exists for your benefit, it doesn’t mean that you have to exercise it. In fact, approximately 98 percent of the successful lease-renewal agreements that The Lease Coach negotiates for tenants don’t include exercising the renewal-option clause at all. That’s because the vast majority of landlords want to retain their tenants in the property, paying rent.

Determine how many years your lease-renewal term should be. Most lease-renewal terms are the same length as the initial lease term. Therefore, if a medical office tenant signs an initial 10-year lease term, the landlord will commonly grant one 10-year renewal option term. We remember coaching a healthcare tenant who planned to invest a great deal of money in building out his practice to accommodate multiple doctors. The decision was made for an initial 12-year lease term with one eight-year renewal option. Although there are no hard and fast rules, landlords resist giving a renewal-option term that’s longer than the initial term. The larger the financial investment you make in a location, the longer or more renewal-option terms you typically want or need.

Remember, a renewal-option term for the tenant doesn’t give the landlord any particular benefit. From your perspective, it may be better to have several short options terms, because longer may not be better. Also, if you can persuade the landlord to agree to a renewal-option term that’s up to five years as determined by the tenant, you can have maximum flexibility to exercise your renewal-option term, but potentially for a shorter period of time, such as two or three years. You normally must make a full-term commitment if you exercise the renewal-option, but just because you have an initial 10-year lease term, with a 10-year renewal-option, this may not be ideal. What if you only want to renew for just two more years?

As another note, the majority of lease agreements don’t preset the rental rate for the renewal-option term, for a couple of reasons:

Landlords want to be able to maximize the return on their real estate investment. No one has a crystal ball, so the landlord is simply keeping options open for the maximum future rent increase possible.

A landlord can constructively evict an undesirable tenant by simply dictating a much higher rental rate on the renewal term than is justified. So, the tenant, thinking the landlord is crazy, relocates the business and landlord does a deal with a more desirable tenant. This can be avoided by insisting on an arbitration clause to determine the fair market value in the event of a disagreement on this rate.

Finally, watch out for a landlord who might hedge their bets by including language in the renewal-option clause that states “Under no circumstances (if the renewal-option clause is exercised) can the rental rate go down”. If you’ve done your homework and determined that market rental rates have declined, then exercising the renewal-option clause can actually work against you. 

For a copy of our free CD, Leasing Do’s & Don’ts for Commercial Tenants, please e-mail your request to DaleWillerton@TheLeaseCoach.com.

Dale Willerton and Jeff Grandfield – The Lease Coach are Commercial Lease Consultants who work exclusively for tenants. Dale and Jeff are professional speakers and co-authors of Negotiating Commercial Leases & Renewals For Dummies (Wiley, 2013). Got a leasing question? Need help with your new lease or renewal? Call 1-800-738-9202, e-mail DaleWillerton@TheLeaseCoach.com or visit www.TheLeaseCoach.com.

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