Option to renew

How renewal rent is set

• A stated rent schedule. The most valuable form for a tenant, because the price is known at signing.
• Fixed escalation, such as the prior rent increased by 3 percent or by CPI. Predictable, and in a soft market it can price above the market rate, so pair it with a right to decline.
• Fair market rent. The most common and the most contentious. Everything depends on the definition and the process.

Getting fair market rent right

A workable FMR clause specifies the comparable set: comparable space in comparable buildings in a defined submarket, for comparable term and size, taking into account concessions actually being granted such as free rent and allowance. Without the concessions language, a landlord can point to headline rents in deals that carried six months free and an $80 allowance, and the tenant renews at a rate nobody actually pays.

The process matters as much. A workable structure: the landlord proposes a rate, the tenant has a stated period to accept or object, and on objection each side appoints an appraiser, with a third appraiser or baseball arbitration to resolve. Baseball arbitration, where the arbitrator must select one of the two submitted numbers rather than splitting, produces more reasonable submissions from both sides.

The window is the trap

Options typically must be exercised no earlier than 12 months and no later than 6 to 9 months before expiration. Exercise outside the window and the option is void. This is the single most common way a valuable option is lost, and it is entirely preventable with a critical date calendar built from the lease abstract.

Where possible, negotiate that the option does not lapse until the landlord has given written notice that the window is open and a short period has run. Landlords accept this more often than tenants expect, because it costs them nothing if they simply send the notice.

Conditions on exercise

Watch for conditions that the tenant not be in default, that it occupy the whole premises, that it not have assigned or sublet, and that the option be personal to the original tenant. Each is a way for the option to evaporate, and each shows up as a short insertion in a landlord redline.