Renewal Options/Extensions

[Frank J.]

I am in negotiations with for a 5 year lease. There is an additional proposal by the tenant for two 5 year options. This is typical and something we have dealt with before. I just wanted to see how others handle the renewal option. Fixed rate? FMV rate(how do you determine FMV?), CPI?

[Nicholas Daddis]

Frank:

My recommendations, in order:

1)  Fixed Rate - Renegotiated established fixed rental increases serve to streamline the option rent process. Nothing to calculate, nothing to negotiate, everything spelled out.

We tend to prefer this method. Our lenders prefer this as well.

2)  CPI Increase - Easiest to sell to Tenants. It’s a “more fair” method for all parties, at least in the eyes of the Tenant. The increase is determined by the CPI data, and neither side can influence or manipulate the outcome.

CPI Choices to be made -

Which index to use (CPI or CPW, or other index). Method to substitute another similar index should the CPI/CPW no longer exist.

How much of the CPI increase will apply to the base lease rate (50%, 75%, 100%?).

How frequently will the rent be CPI/CPW recalculated during the option periods? (Beginning at year six, then year eight, year ten, etc, OR only once per five-year renewal period, at year six and year eleven?)

I also strongly recommend you add language that:

a) The option rent will never be less than the preceding rent,

b) The rental increase calculated with the CPI will not be less than $x.xx (what we call a floor). This gives you a guarantee of a minimal rental increase should the CPI calculation be low, something you can't control but with this method you have a "worst-case" floor minimum rate increase you can depend upon.

c) If the Tenant objects to the "minimum floor rate", offer to counter with the addition of a maximum "ceiling rate" that the Tenant could be obligated to pay. This way both the Landlord and Tenant have a minimum and maximum CPI range they can expect and budget. it is almost impossible to argue that a minimum floor with a maximum ceiling isn't a fair compromise for both parties.

3) Fair Market Value - This requires extensive detail to define what is "Fair Market Value", how it is calculated. The more vague and lacking in detail that this concept is left to, the more difference of opinion of what Fair Market Value is.

I also strongly recommend you add language that:

a) Define precisely what comparable market rent is to be surveyed. Be very precise, such as Pizza Parlor use, major franchisees, within a specific market area or city neighborhood, of similar lease terms and lease areas, etc. You don’t want your comparable market rent to be from a low rental taylor shop for example.

b) Take into account the buildout or tenant finish, free rent, percentage rent (if applicable), expenses paid by the landlord and tenant, and any other unique contributions or concessions made by the landlord for this specific tenant. This influences the lease rate. If there is no tenant finish, no free rent, no percentage rent then the comparable rent that is attempting to be used will be low and not comparable to your lease.

c) Define who will determine Fair Market Value. Will it be a appraiser, an MAI appraiser, a local retail broker, or simply an average of comparables that are collected by a qualified person.

d) The Fair Market Value will not be less than the previous periods rent. You might also want to add a minimum "floor" rate as described above.

Any of these three methods will work provided you include the detail I have suggested.

Good luck, and as they say, "get the lease signed"!

Regards,

Nicholas, CCIM