So, continuing my conversation with Sam Johnson (purveyor of big cats and craft beer) about the lease he desperately wants to sign. After all, he’s solved location and price. What else is there?
In my effort to display to him the wisdom of having me review the lease, I told him I would identify five issues that go beyond price and location and that, if not addressed, change his new place of heaven to a five-year hell.
The first issue I discussed was use allowed under the lease. The next is renewal.
“Renewals?” asks Sam. “Got that covered. Jim, my new landlord, says he’s happy to discuss giving me another five years when my current term is up.”
“OK, so did he say how you have to exercise your option to renew? Did he even really give you an option, or just a promise to discuss maybe letting you renew?” I asked.
Sam wanted to know what I meant.
Renewals can be tricky business. For instance, a promise by the landlord to discuss maybe letting you have another five years is just that – a promise to consider negotiating an extension. Significant terms such as 1) how to exercise the option, 2) how long is the option good for, and 3) what is the rent under the extension are some crucial points that need to be nailed down in order for a renewal option to be binding.
Let’s examine each one individually.
Assume the landlord has given you a binding option to renew. The lease likely will describe the process by which you exercise that renewal. Some common terms are that if you want to renew, you must do so within a very specific window of time, say no earlier than 180 days before the end of the original term and no later than 120 days before the end of the term. Thus, you have a 60-day window to notify the landlord that you want to renew.
If you forget or miss the deadline by even one day, the option is dead, kinda like the prey you offer your lions for their lunch.
Also, the option generally defines how it is exercised, like in a writing delivered to a certain address. Again, if you fail to follow the exact instructions (such as letting the landlord know by way of an email or text message) and do not satisfy the outlined procedure, you will deprive yourself of the option.
The length of the option generally matches the length of the initial term – but not always. Maybe you don’t want to be tied into this location, so ask for a shorter option. Also, the length of the option term can be used to give you some stability if things work out well there while giving you some flexibility in case your beer sales go flat (hopefully not like your brew).
Remember – right now is when you have the most leverage, the most bargaining power. Use it to your advantage. You probably won’t have the same opportunity later.
Finally, you and the landlord can decide now how much rent will cost you in the option term. But, be careful. Many landlords try to impose what is called a “Market Rate.” Essentially, after you follow the correct procedure to exercise your option, the landlord then reviews what rent for similar buildings are going for in the marketplace and sets the rent based on that. So, if other breweries or animal parks see how successful you’ve been and consequently have driven up rental rates, you pay the price. Rent could increase by 5% or 10% or even more. And don’t worry about the landlord. They always put in a floor on the new rate so that the new rent will go up by a minimum of 3%. Thus, reject any attempt to put the new rate at market rate.
Another way to determine rent is for it to match the cost of living Index, showing the increase in COL from the beginning of the lease to the option date. (There will probably be a 3% floor increase built in, so your rent is not going down.) This is more objective and better than market rate, which will vary depending on which real estate professional you consult.
The best rate is one that is predetermined, either a specific dollar amount or a flat percentage increase. This is the best because you can plan for it, making your decision about whether to renew or not, much easier.
So, you now see that options are an integral part of the lease.
Next issue, exclusivity. ©