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Lease Renewal in Commercial Real Estate
Commercial leases can last as little as a few months, or as long as 20 years or more. In contrast, multifamily apartment leases are typically 12 months, with some leases ranging as long as 24 months. However, before a lease is up, a landlord has the option of allowing a tenant to renew their lease. Whether they want a tenant to renew is up to several factors, including the tenants behavior, as well as individual factors involving the property.
- Lease Renewal: What You Need to Know
- Check Renewal Rights Before Making Decisions Involving Commercial Lease Renewal
- In General, Renewal Clauses Benefit Property Investors/Landlords
- Lease Renewal for Multifamily Properties
- Questions? Fill out the form below to speak with a commercial real estate loan specialist.
- Related Questions
- Get Financing
Lease Renewal: What You Need to Know
Commercial leases can last as little as a few months, or as long as 20 years or more. In contrast, multifamily apartment leases are typically 12 months, with some leases ranging as long as 24 months. However, before a lease is up, a landlord has the option of allowing a tenant to renew their lease. Whether they want a tenant to renew is up to several factors, including the tenant’s behavior, as well as individual factors involving the property.
For instance, if a landlord wanted to offer more of a retail property to an expanding anchor tenant, they may not want to renew leases for tenants in nearby stores. Or, if a landlord wanted to do a significant rehabilitation of an apartment building, they may choose to not renew any leases for the year in which the repairs are planned to occur.
Check Renewal Rights Before Making Decisions Involving Commercial Lease Renewal
In some commercial leases, tenants may have a right to renew their lease after the expiration is up. Sometimes, this is referred to as “right to renew”, while in others it’s called “option to extend”. If you and your tenant have agreed upon a lease with a right to renew clause, it will typically have a notice period, the time prior to the lease expiration during which a tenant can exercise their right to renew the lease. This is often 6 months before expiration, but it is often 3 months for smaller tenants, and 9-12 months for larger tenants.
In addition, some lease renewal clauses allow a tenant to lock in a specific rate, while others allow the landlord to set the rent at a fair market price. Many commercial lease renewal clauses also posit that the landlord will not have to do any work on the premises prior to the lease renewal, i.e., that the property must be accepted “as is”.
In many cases, commercial landlords will set specific terms that a tenant must abide by in order to be offered a renewal option. For instance, a landlord may stipulate that a tenant may not default on their lease or pay it late if they wish to renew. However, a landlord generally has to inform the tenant of their violation within a certain time frame in order to deny their lease renewal. Another potential term could involve allowing the landlord to rehabilitate the property at a certain point in the future, which could disrupt the operation of the tenant’s business.
In General, Renewal Clauses Benefit Property Investors/Landlords
If you own commercial property that you rent to tenants, having them agree to a lease renewal generally means that they cannot argue any other aspects or clauses of the commercial lease. In general, this is to your benefit, as they may later wish to request expensive concessions like property improvements, which you may not be in a financial position to grant. If, however, they have already agreed to renew, they cannot use a potential lease renewal as a bargaining chip.
In some situations, lease renewal agreements stipulate rent floors or rent ceilings, specific amounts that rent cannot exceed (a rent ceiling), or specific amounts that the rent cannot fall below (a rent floor). As one might expect, rent ceilings benefit tenants, while rent floors benefit landlords.
Lease Renewal for Multifamily Properties
For large multifamily properties, lease renewal is typically handled by a property management company rather than by an investor themselves, but investor/developers should still be extremely familiar with the process. In general, residential tenants have significantly more rights than commercial ones, however, landlords still do not have to automatically renew a lease. However, unless a tenant’s behavior has been particularly egregious (i.e. disrupting other tenants, destroying property, or repeatedly missing payments), it’s often in a landlord’s best interest to renew. An average of 54% of apartment leases turn over each year, costing landlords an average of $1,750/month of vacancy. As this can get incredibly expensive, especially when dealing with multiple units in multiple properties.
See also: Lease assignment
Questions? Fill out the form below to speak with a commercial real estate loan specialist.
Related Questions
What are the most important factors to consider when renewing a commercial real estate lease?
When renewing a commercial real estate lease, it is important to consider the following factors:
- The notice period prior to the lease expiration during which a tenant can exercise their right to renew the lease.
- Whether the lease renewal clause allows a tenant to lock in a specific rate, or allows the landlord to set the rent at a fair market price.
- Whether the landlord will have to do any work on the premises prior to the lease renewal.
- Any specific terms that a tenant must abide by in order to be offered a renewal option.
- Whether the landlord can rehabilitate the property at a certain point in the future, which could disrupt the operation of the tenant’s business.
What are the benefits of renewing a commercial real estate lease?
The benefits of renewing a commercial real estate lease include:
- The tenant cannot argue any other aspects or clauses of the commercial lease.
- The tenant may have the option to lock in a specific rate.
- The landlord may not have to do any work on the premises prior to the lease renewal.
- The tenant may be able to set rent floors or rent ceilings.
Source: www.commercialrealestate.loans/commercial-real-estate-glossary/lease-renewal
What are the potential risks of renewing a commercial real estate lease?
The potential risks of renewing a commercial real estate lease include:
- The tenant may request expensive concessions like property improvements, which the landlord may not be in a financial position to grant.
- The tenant may be locked into a specific rate, or the landlord may set the rent at a fair market price.
- The landlord may not have to do any work on the premises prior to the lease renewal, i.e., the property must be accepted “as is”.
- The landlord may set specific terms that a tenant must abide by in order to be offered a renewal option, such as not defaulting on the lease or paying it late.
- The landlord may be allowed to rehabilitate the property at a certain point in the future, which could disrupt the operation of the tenant’s business.
What are the common terms and conditions of a commercial real estate lease renewal?
Common terms and conditions of a commercial real estate lease renewal include a notice period, rent floors or rent ceilings, acceptance of the property “as is”, and stipulations that the tenant must abide by in order to be offered a renewal option. The notice period is typically 6 months before expiration, but it is often 3 months for smaller tenants, and 9-12 months for larger tenants. Rent ceilings benefit tenants, while rent floors benefit landlords. Additionally, some lease renewal clauses allow a tenant to lock in a specific rate, while others allow the landlord to set the rent at a fair market price. Lastly, a landlord generally has to inform the tenant of their violation within a certain time frame in order to deny their lease renewal.
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What are the best strategies for negotiating a commercial real estate lease renewal?
The best strategies for negotiating a commercial real estate lease renewal depend on the specific terms of the lease. Generally, it is beneficial for landlords to include a renewal clause in the lease that stipulates rent floors or rent ceilings, specific amounts that rent cannot exceed (a rent ceiling), or specific amounts that the rent cannot fall below (a rent floor). Additionally, landlords should consider setting specific terms that a tenant must abide by in order to be offered a renewal option, such as not defaulting on the lease or paying it late. Lastly, landlords should consider allowing the tenant to lock in a specific rate, while also allowing the landlord to set the rent at a fair market price.
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What are the most common mistakes to avoid when renewing a commercial real estate lease?
The most common mistakes to avoid when renewing a commercial real estate lease include:
- Not checking renewal rights before making decisions
- Not understanding the notice period
- Not understanding the rent rate terms
- Not understanding the landlord's terms for renewal
- Not understanding rent floor or rent ceiling terms
Source: www.commercialrealestate.loans/commercial-real-estate-glossary/lease-renewal