Saturday, August 30, 2014

The Pros and Cons of Lease Options in Commercial Real Estate Investment Property Leasing

Lease options should be carefully considered


When negotiating a lease in commercial investment property with a tenant, they are likely to ask for an option for a further lease term as a period of years. They may also ask for multiple options to be available and renewable through the terms of the lease. Before agreeing with that lease option requirement, understand the plans of the landlord when it comes to that particular property; also look into the age factors and the physical tenant mix changes that may be required over time.

So exactly what is the problem? A lease option will tie up the property from an investment perspective. The lease options are normally at the discretion of the tenant, and on that basis the landlord can as a result of a tenants option to renew, be restricted from implementing investment changes in the tenancy mix, improving the property through renovation, and expanding the property with further tenants.

In any new or relatively new property the option availability or process may be quite acceptable providing that the option term is not overly long. Typically most options will be for multiples of three or five years.  It is worth noting that the owners of larger shopping centres will not normally grant lease options in a lease negotiation given that they restrict property and tenant mix changes.

Here are some further thoughts on the ‘option’ matter for you to consider and potentially implement as the local investment property leasing specialist within your property type:


  1. To achieve or retain tenant mix control for the landlord it is wise to restrict your lease option negotiations to sensible and short additional lease terms that do not frustrate further property activity and improvement.  Consider the future in all you lease negotiations.
  2. Understand the age of the property and the pressures of renovation and refurbishment that will apply from time to time. As the property ages, it is wise to consider shorter lease terms and the use of renovation clauses obligating the landlord and/or the tenant to undertake certain works to maintain and improve tenancy presentation.
  3. Stagger your lease expiry dates so you don’t have too many leases expiring at the same time in the one property.  In that way you can then focus on filling vacancies before they fall due.
  4. If the tenant is to be given a reasonable lease term with extra options, understand the impact of the permitted use granted in the lease in case that permitted use has implications for other tenants within the property.
  5. In any long lease or lease that has multiple options, ensure that the rental is reviewed to market from time to time (generally at least once every 3 or 4 years). In that way the landlord can achieve the correct levels of return that apply to the property type given current market rental negotiations.
  6. The levels of supply and demand as they relate to the property type and the location will have an impact on available space and lease negotiation. Monitor the upcoming property developments and the impact that they may have with properties that you lease and manage.  Look for the threats of change with any oversupply of available space.


So the message here is quite clear when it comes to lease options in any investment property. If you are going to negotiate and grant lease options to tenants as part of any lease negotiation, take the time to understand future of the location, current elements of the property performance, the landlord, and the local property market. Only allow lease options to be agreed to where the landlord’s investment strategy is supported and strengthened.

You can get more leasing tips at our main commercial real estate leasing training website here.