How can you use lease renewal options to increase the value of a commercial property?

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Lease renewal options are clauses in a commercial lease that give the tenant the right to extend the lease term under certain conditions and rates. These options can benefit both landlords and tenants, but they can also affect the value of the commercial property. In this article, you will learn how lease renewal options work, what factors influence their value, and how you can use them to increase the value of your commercial property.

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Viashen Gounden

Pharmacist, Commercial / Residential Building Developer : goundenproperty.com | whiteswanpharmacy.co.nz

1 What are lease renewal options?

A lease renewal option is a provision in a commercial lease that allows the tenant to renew the lease for a specified period of time, usually at a predetermined rent or a rent based on a formula or market rate. Lease renewal options give tenants flexibility and security, as they can avoid relocation costs and maintain their business location. Lease renewal options also benefit landlords, as they can reduce vacancy and turnover costs, retain good tenants, and increase cash flow stability.

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Ignacio López-Hermoso
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According to my experience, both parties aim to fulfill and maintain the lease, especially when substantial investments have been made. However, various circumstances can alter these initial intentions. For example, a landlord might choose to terminate the lease to take over a tenant's successful business operation. Alternatively, shifts in market conditions could necessitate rent adjustments so significant that they lead to non-renewal of the lease. In either scenario, these actions invariably affect the expected profitability and associated costs for both parties. These financial implications may vary based on the type of business and any related renovation or adaptation costs for the premises

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2 How do lease renewal options affect property value?

The value of a commercial property is largely determined by its income potential, which depends on factors such as occupancy, rent, expenses, and capitalization rate. Lease renewal options can affect these factors in different ways, depending on the terms and conditions of the option. For example, a lease renewal option with a fixed rent below the market rate can lower the income potential and the value of the property, while a lease renewal option with a rent based on market rate or a formula can increase the income potential and the value of the property. Similarly, a lease renewal option with a long term can increase the value of the property by reducing the risk of vacancy, while a lease renewal option with a short term can decrease the value of the property by increasing the uncertainty of future income.

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3 How to negotiate lease renewal options?

When negotiating lease renewal options, landlords and tenants should consider a variety of factors. Landlords should take into account the market conditions and demand for the property type and location, as well as the tenant's creditworthiness, business performance, and relationship with the landlord. They should also consider the length and frequency of the lease renewal option, rent and rent adjustment method, notice period and procedure for exercising the lease renewal option, and maintenance and improvement responsibilities and costs. Tenants should consider their current and projected needs and preferences, availability and cost of alternative properties, terms and conditions of the existing lease and lease renewal option, rent and rent adjustment method, notice period and procedure for exercising the lease renewal option, as well as maintenance and improvement responsibilities and costs.

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Ignacio López-Hermoso
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The type of property is crucial. There are numerous commercial spaces that, once leased, offer a compelling investment opportunity. However, the unique characteristics of some properties may result in a slow and costly process when entering the market. In such instances, it may be advantageous to sacrifice some immediate profitability in favor of longer-term gains. The negotiation of minimum commitment periods can be another important aspect to consider in these cases.

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4 How to use lease renewal options to increase property value?

Lease renewal options can be used to increase the value of a commercial property by enhancing its income potential and reducing its risk. Landlords should consider offering lease renewal options with market-based or formula-based rents that reflect current and future value, reasonable terms that balance tenant flexibility and landlord security, and incentives or concessions that encourage tenants to renew the lease. Additionally, it is important to monitor market conditions and tenant performance, as well as communicate and negotiate with tenants in a timely and professional manner to exercise or modify the lease renewal option.

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Viashen Gounden

Pharmacist, Commercial / Residential Building Developer : goundenproperty.com | whiteswanpharmacy.co.nz
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If the probability of a tenant being stable long-term is significantly high, then the agreement should conform to their requirements. Stable tenant = stable income = enhanced overall commercial building value. As uncertainty lingers around global recovery, it's prudent to work mutually

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5 How to evaluate lease renewal options when buying or selling a property?

Evaluating lease renewal options when conducting due diligence or appraisal is critical to the value of a commercial property when buying or selling. Buyers and sellers should review the lease documents to identify the options and their terms, analyze the rent and rent adjustment method, estimate the probability and timing of tenant exercising the options, and calculate the present value of the options. Furthermore, they should adjust the value of the property based on the risks and benefits of the lease renewal options.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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Ignacio López-Hermoso
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In some jurisdictions, legal frameworks dictate the indemnification owed to tenants if a lease agreement is not renewed. For instance, Spanish law safeguards tenants when landlords opt not to extend the lease unilaterally. While this provision can be contractually waived, if not excluded, it entitles the tenant—provided they expressed an intent to renew—to seek damages. Specific methodologies for calculating these damages are stipulated by law. The presence or absence of this clause becomes pivotal during due diligence or appraisal processes for the property in question.

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How can you use lease renewal options to increase the value of a commercial property?

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1 What are lease renewal options?

2 How do lease renewal options affect property value?

3 How to negotiate lease renewal options?

4 How to use lease renewal options to increase property value?

5 How to evaluate lease renewal options when buying or selling a property?

6 Here’s what else to consider

Commercial Leasing

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How can you use lease renewal options to increase the value of a commercial property?

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1 What are lease renewal options?

2 How do lease renewal options affect property value?

3 How to negotiate lease renewal options?

4 How to use lease renewal options to increase property value?

5 How to evaluate lease renewal options when buying or selling a property?

6 Here’s what else to consider

Commercial Leasing

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