When negotiating a commercial or retail lease, landlords and tenants should consider whether to include an option to renew.

What is an option to renew?

An option to renew is a provision in commercial and retail leases allowing the tenant to require the landlord to grant them a new lease at the end of the existing lease. The new lease is usually on the same terms as the existing lease, with the rent updated. The terms of the option lease can only be varied by mutual agreement.

From the tenant’s perspective, an option provides the security of a longer term. An option gives a tenant the ability to secure the premises for a further period, and the flexibility to instead decline taking up the option and end the lease. No one has a crystal ball: businesses fail, grow, shrink, change, and preferences change. A tenant would want the flexibility to stay on in premises if desirable but also to move on if necessary.

Exercising an option to renew

The mechanism for exercising the option to renew is set out in the lease terms. The renewal process usually includes the following requirements:

1. written notice must be sent to the landlord or managing agent of intention to exercise the option;
2. the notice must be provided within a certain period as set out in the lease – often six to three months before the terminating date of the current term;
3. the tenant must not be in breach or default of the lease (e.g. in rental arrears); and
4. the tenant must comply with any pre-agreed requirements for the renewal (e g. that they will refurbish the premises).

Landlord’s obligations on exercise of the option

If the notice to exercise the option to renew is validly served on the landlord the landlord must:

1. prepare the new lease on the same terms (unless varied by the terms of the original lease or by mutual agreement) for the further term; or
2. register with NSW Land Registry Services a variation of lease extending the current lease and incorporating any agreed changes for registration; and
3. facilitate execution of the documents by all parties and register the variation and new lease.

Depending on the terms of the lease and whether it is a retail lease, the landlord may require the tenant to pay the costs of preparing the new lease, variation and registration costs.

Failure to exercise the option

If a tenant intends to stay on in the premises, failing to exercise the option to renew can be catastrophic. If the procedure for exercising the option is not followed properly, then the landlord is under no obligation to grant a further term. In that event, the lease will terminate and the landlord can require the tenant to vacate the premises at the end of the term.

If a tenant fails to exercise the option validly, the landlord can choose to renew the lease or to negotiate fresh lease terms. This puts the tenant at a significant disadvantage: the landlord may require a rent increase or other unfavourable terms that could have been avoided by renewing the lease validly.

In some cases the landlord will allow a tenant to remain in the premises as a periodic tenant. The tenancy will be on the same terms as the original lease, but the landlord can increase the rent and the lease can be terminated by either party on one month’s notice. Again, the terms of the lease may stipulate terms for periodic tenancies.

Takeaways

Exercising an option to renew can be a simple and straightforward process with little stress. However, if timeframes are not met or the mechanism in the lease is not properly followed, tenants can be left in a precarious position. This can happen when tenants forget about these requirements or are not properly advised about the requirements in the first place.

The starting point for tenants is whether an option to renew is included in the lease. When negotiating a lease, tenants should consider whether an option should be included and the terms of that option. For many tenants, a properly negotiated option can be incredibly valuable.

If the lease includes an option to renew, to avoid any unnecessary issues, tenants should:

1. familiarise themselves with the option to renew mechanism and requirements at the beginning of the lease;
2. Write down the key dates to exercise the option and diarise a reminder so it is not missed;
3. Ensure that a notice to exercise the option unequivocally expresses the intention to exercise the option; and
4. Comply with the lease requirements when serving the notice (i.e. service by email or post).

Landlords should familiarise themselves with the mechanism, requirements and dates for lease renewals, and their rights if a tenant fails to comply with the lease requirements.

Here to help

Contact us if you need advice about options to renew commercial and retail leasing.