Renewals of Retail Commercial Leases
When understanding commercial leases, ambulatory care and urgent care owners and operators should be aware of their renewal options and their ability to negotiate the terms.
“If you want an option to renew, you need to negotiate that provision when you negotiate the original lease; otherwise, your ability to renew at the end of the term depends on you reaching a new agreement with your landlord,” Carmin Grandinetti, Partner at Bingham Greenebaum Doll LLP, says. “In that case, landlords will opt for a simple amendment where the only items that change are the new term and the new rate.”
If you want to negotiate a renewal at the time you negotiate the original lease, the principal issue will be the new rental rate. Grandinetti says that often, the renewal rate will be stated as a percentage of the prevailing market rate. For example, it may be 95% of what your landlord is currently offering new tenants on the date of your renewal.
“In other words, you’ll renew at a rate equal to 90-95% of the prevailing rate the landlord is currently offering to tenants at the time of the renewal,” Grandinetti explains. “Sometimes, you may be able to negotiate a hard rate though, which would be your previous rate plus a 3% increase.”
“Often times the payment terms are negotiated upfront when you sign the initial lease – it may tell you that your rate is going to be ‘x’ amount a year for the first year, and then there will be a 5% increase each year,” Brian Berlandi, Partner and Co-Founder of Berlandi Nussbaum & Reitzas LLP, says. “If you exercise the option to renew, then that increase may remain the same, or it may increase or decrease.”
Jim Taylor, Partner at Milligan Lawless, P.C., says it’s important for tenants to clearly understand how their lease rate is going to be established for the renewal term.
“A lot of times, it’s left up to market rent, and if you don’t have a mechanism for determining market rent, or coming to an agreement on what that rate is, that can be a problem,” Taylor says. “Maybe it’s market rent, but not more than 3-5% of the amount of rent paid during the last year of the initial term.”
In many cases, you’ll have to negotiate renewal options upfront when you sign the initial lease.
“Landlords want it that way so that when the renewal time comes, tenants aren’t trying to lower the price,” Berlandi says. “Some leases don’t have that though, and you can negotiate things like adding more or less space at the time of the renewal. Both parties can see a renewal as an opportunity to negotiate new terms.”
If you’re going to renew your lease, you may also be able to negotiate some tenant improvement (TI) costs with your landlord.
“A lot of times landlords will negotiate an additional TI allowance when you exercise the renewal,” Taylor says. “If the tenant does not exercise the renewal options, the landlord is going to have to offer TIs for a new tenant, so in the long run, it may be less expensive for the landlord to offer additional TI money to update the space for a renewal tenant.”
“Maybe the renewal period comes around, and you want to renew but realize that you need additional space,” Berlandi says. “Part of the negotiation can be that you’ll exercise your renewal option and stay another 10 years, but the landlord has to give you $15,000 of improvement credit or pay for certain improvements to the space.”
The length of your lease may affect how much TI money you can negotiate.
“You’re going to be less likely to get that with a five-year lease and two renewal terms of two years – that’s only nine years,” Taylor says. “But if you have a five year lease with two five-year renewal terms, you may be able to negotiate more money.”
Grandinetti says that you should negotiate how much TI money you want in relation to what percentage of the prevailing rate you want.
“They’re inversely proportional to one another, so you can offset the balance between the TI and the percentage of the prevailing rate,” Grandinetti explains. “The more TI you want, the closer you’ll be to the prevailing rate.”
It’s best to negotiate for a renewal option when signing the initial lease, and then negotiate the terms of the renewal when you actually renew.
“If at the outset of the lease, you believe that you’re only going to be there short-term and the property values are likely to decline, you may not want to lock yourself into a renewal clause with pre-determined rent increases,” Berlandi says. “But on the other hand, if you want to stay there long-term and you are confident that the market values will increase, you might want to agree upon a renewal option at pre-determined prices so you don’t have to worry about it later – you’re locked in.”
“You need to negotiate renewal options at the time of the initial lease, because developing bargaining power at the end of a lease is unlikely unless other tenants are leaving and the building is no longer in a desirable area,” Taylor says. “If the area or building is desirable though, you may not have negotiating power for a renewal option at the end of your lease. Your landlord will have to decide if it’s easier to keep a known tenant in place and deal with negotiations, or try to find someone new. If the landlord is going to be able to get more money from a new tenant, they may go through the hassle of bringing in someone new.”
Taylor says it’s also extremely important to pay attention to the notice of renewal, and the time in which you’re supposed to provide that notice.
“Even if you have a wide window like 6-12 months, you have to have a good calendaring system in place to make sure that you provide the appropriate notice,” Taylor says. “If you’re in a desirable space, you don’t want to mess up your right to renew because you didn’t provide the appropriate notice.”
He also recommends that urgent care centers negotiate an exclusive in their agreement.
“You want to get an exclusive in the agreement, and you want to do that before you exercise your right to renew,” Taylor says. “Once you exercise your right, your lease terms are stuck. If the area is growing or it’s a productive area, then the landlord may be less willing to negotiate because there may be other willing tenants waiting to take over.”
If your lease is coming to an end, and you want to renew but want to do so in a different spot in the commercial space, you may have the option to do so.
“It’s not unusual for businesses to move from one spot to another because you may not have gotten the office space that you initially wanted,” Grandinetti says. “If a better location comes up and you’re in the middle of your lease, you could even talk to your landlord about the possibility of moving then.”
However, you’re probably going to want to move to that spot because it’s a bigger and/or better location, and that can have some drawbacks.
“You’re probably going to have to pay more rent, so is it really in your best interest to move?” Grandinetti asks. “In addition, you’ll have to pay for moving costs.”
If everything stays the same, Grandinetti says that your move will be a zero next gain for your landlord – they’re not going to be incentivized to move you unless they think they’ll be able to relet your existing space to another tenant. For example, the landlord may combine your old space with the adjacent space, and have a larger space that a new or adjacent tenant may prefer.
“If you have to refurbish the new location, that’s an investment by your landlord, but their occupancy hasn’t changed. Unless someone is coming to take over your old space, a landlord is going to be very reluctant to invest in something that gains them very little,” Grandinetti says. “You’ll never know unless you ask, but remember that when you’re looking for other space, and you’re also looking to move with same landlord, it will be a negative for that landlord to move you, so they’ll probably make you pay for that.”
When it comes to renewals of retail commercial leases, Grandinetti says you need to evaluate your business plan, where you want to be, what the alternatives to your location are and how much it would cost to move.
“If you have the best location in the world, and it’s going to remain the best location in the world for awhile, your renewal decisions are going to be different than if you’re in an average location, and you think another location may be better,” Grandinetti says. “It’s a business judgment, and you have to understand the environment and the demographics of the market that you’re in. If you think the demographics will be there for awhile, it may be in your best interest to lock in your lease with renewal options.”
If you have an interest in learning more about the subject matter covered in this article, the M&A process or desire to discuss your current situation, please contact Blayne Rush, Investment Banker at 469-385-7792 or Blayne@AmbulatoryAlliances.com
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