Negotiating a More Flexible Lease | 4 Great Tenant Options

In even the best of economic times, negotiating for increased commercial lease flexibility is a sound business decision.  Forecasting commercial space requirements 3, 5, or 10 years in advance can seem like an impossible - and foolhardy - task.

Unfortunately, though, there’s an inherent friction between business needs and commercial lease requirements.  Commercial landlords typically require a long-term lease, and businesses often feel pressured into accepting these terms, despite lacking fidelity on what their business needs will entail for the duration of the lease.  

However, businesses do have alternatives to rigid, long-term leases, and in this article, we’ll discuss four options commercial tenants have to negotiate a more flexible lease with their landlords.

Option 1: Termination and Contraction

This first option provides commercial tenants increased exit flexibility, that is, the ability to opt out of all or part of a commercial lease. 

While somewhat similar in outcome, termination and contraction are two separate lease flexibility clauses:

●      Termination: A termination clause allows a tenant to officially end a lease, and it is typically paired with very specific timeline guidance on when a tenant needs to provide notification.  Furthermore, this sort of clause will likely include a penalty, either in the form of pro rata rent or unamortized lease costs.

●      Contraction: For larger tenants, flexibility may come in the form of a smaller footprint.  A contraction clause allows tenants to reduce their square footage prior to a lease ending, though it typically can only be executed at certain milestones and will likely also include some sort of penalty. 

Numerous considerations exist for commercial lease termination and contraction clauses, so please drop us a note for help developing a negotiation strategy.

Option 2: Assignment and Sublease Rights

Similar to the above options, assignment and sublease rights provide commercial tenants exit flexibility in crafting a lease. 

Though often used interchangeably, assignment and sublease mean two different things for a commercial tenant, and it’s critical that businesses understand the liability - or lack thereof - associated with each lease clause:

●      Assignment: When a tenant assigns its lease rights and obligations to another tenant, the new tenant substitutes for the original one, and the original tenant is no longer bound under the lease.

●      Sublease: Unlike an assignment, when a tenant subleases a space, the new tenant occupies the space, but the original tenant remains liable for the contractual obligations of the lease.  While this provides less risk for a landlord, subleasing is a potentially hazardous situation for the original tenant due this continued liability. 

Local commercial real estate professionals can help you craft assignment and sublease strategies - need help finding reliable ones in your area? Drop us a note!

Option 3: Renewal

Whereas the first two options provide tenants the flexibility to get out of leases, these next two focus on the flexibility to retain or expand commercial leases. 

For businesses, relocating can be an enormous expense, and the process can significantly disrupt operations.  As such, having the option to renew your current lease offers considerable operational flexibility. 

A renewal option is just what it sounds like: the right for a tenant to extend its lease beyond the original termination date.  And, ensuring this clause is included in a lease allows businesses the win-win of A) not needing to forecast business needs too far into the future and sign an extremely long-term lease, and B) stay or go at the conclusion of a lease term. 

Option 4: Expansion

For growing businesses, an expansion clause is critical to a well-designed and flexible lease.  If you’re anticipating significant growth over the next five years, it doesn’t make sense to lease a commercial space for your projected needs five years down the line.

With an expansion clause, commercial tenants ensure they have the option - but not requirement - to expand into new or adjacent space if the need arises in the future.  The following are three common variations of an expansion clause, all of which provide growing businesses tremendous lease flexibility:

●      Hold options: When a landlord has additional space, a hold option provides a tenant a set period of time to exercise an option on a defined space. 

●      First right of refusal: When a landlord has additional space (as with the above), a first right of refusal means that, prior to signing a deal with a third party, the landlord is obligated to present the terms of the deal to the current tenant, who can then preempt the deal by matching the terms.  

●      Right of first offer: If a landlord may have available space in the future, a right of first offer requires the landlord to offer this space to the tenant prior to any third parties. 

Final Thoughts

It’s important to understand that the above options aren’t mutually exclusive, that is, a tenant can seek to make a lease as flexible as possible by including variations of all of them. 

And, while a landlord can impose additional costs for increased lease flexibility, unpredictable market conditions suggest that, for tenants, the pros of increased flexibility outweigh any associated cons. 

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We recognize that, even after outlining the above information, tackling the challenges of commercial lease negotiations can seem daunting.   

That’s why we’re here to help.  The Pocket Broker team lives and breathes commercial real estate, so drop us a note to see how we can help you achieve your unique objectives!