A renewal option is a clause present in an agreement, usually relating to money, that spells out the term for which an original agreement may be renewed or extended. This option often details the condition for which an agreement may be renewed, and specifies how long the additional time would last. A lease renewal option therefore is a clause that is found in a lease agreement and performs the function above.
In lease renewal options, the lessee has the option, but is not obligated to extend or renew a lease agreement. This clause is often beneficial to both entities, but may be more financially beneficial to the property owner.
Putting the Idea in Context
To get a better understanding of this concept, let’s paint a practical scenario. Take for instance, a new restaurant signs a lease agreement for two years, and in this agreement, a lease renewal option is present. At the end of the two-year term, the restaurant owner, we’ll call him jack, has to decide whether to extend the contract or move to a new location.
This decision of course will be influenced by how well his restaurant performed in the last two years. If the location was favorable and Jack’s restaurant had a lot of business within the last two years, the renewal option gives Jack the power to extent the lease agreement. Without this clause, Jack would be kicked out and would have to find a new location for his business.
On the flip side of the coin, if the last couple years had been terrible for Jack’s restaurant, at the end of the term, the renewal option also allows him to close up shop and look for greener pastures. In the same vein, a lessor stands to benefit from renewal options as well.
A whole lot is involved in getting a new tenant. The longer it takes to get one, the more expensive the process becomes in terms of money and effort. This is because the lessor has to spend money marketing the property and also has to show every interested lessee the property, while doing background checks to see if a lessee is a good fit. Click here to learn more about tenant background check.
To save themselves all of this work, lessors will include a renewal option in a lease agreement when they find a tenant that is right for them. That way, hopefully for them, the tenant may decide to extend the terms of the contract, saving them all that trouble.
Importance of a Renewal for Property Owners
While a tenant may feel good about a renewal clause in their lease agreement, a lot of them are unaware of the fact that most of the times, this clause is drafted to favor the lessor much more than them. The reason being that after years of annual renewal by the tenant, the lease rate will be well over the market price. To better understand why lease renewals are important to property owners, let’s consider the following:
- Vacancy period
- Operating expenses
- Marketing rates
- Tenant improvement allowance
- Rent free period
Very often, a vacant space may stay that way for a year or longer, even in a competitive market. During this period, the property owner collects no rent and if the new tenant’s negotiation period is factored in, the lessor may spend up to 24 months without receiving a rent check.
Staying without rent isn’t the only thing a property owner has to worry about. The cost of operating a vacant space for a year could easily sum up to tens of thousands of dollars. Costs like taxes, utilities, and taxes still has to be paid irrespective of the fact that the space is vacant. Visit https://www.designingbuildings.co.uk/wiki/Operational_costs_for_built_assets to learn more about operational expenses.
Marketing a property is another headache lessors have when trying to get new tenants. Hence the reason for a renewal option. When marketing a free space, the property owner often sets the price lower than the market price and what potential tenants are paying in order to remain competitive.
Tenant Improvement Allowance
It’s very rare for a vacated space to meet the new occupant’s preference. This is yet another expense a property owner has to deal with when letting go of an existing tenant. To be able to market the space, it sometimes has to be completely renovated or remodeled. These projects often take thousands to complete.
Rent Free Period
Even after a new tenant occupies the space, they often get a rent-free period, in addition to the time taken to renovate the space and the vacancy period.
Most tenants are unaware that they can negotiate their renewal rates to get prices similar to those of the market and to those a new tenant would pay to occupy the space. Most often, the lessor will be open to such negotiations because they very well know that they stand to lose more if they opt to get a new tenant.