Today you will learn six tips about options to extend your lease that your Landlord wishes you did not know.
You see, most restaurateurs overlook essential details when signing a lease.
Options to extend your Lease are super important and often overlooked.
Ready to outsmart your Landlord?
Let’s get started.
What is an Option to Extend Lease?
The option to extend Lease provides the ability to extend your term of Lease if your business succeeds.
Most restaurateurs will sign a lease for a period of 5 to 10 years.
If your restaurant is successful, you will want to extend the lease term when the Lease expires or sell your restaurant for a profit.
But what if you don’t want to sign a long-term lease?
Since you may be personally liable for the Lease, you may prefer to keep the Lease shorter to hedge your bets if things don’t work out as planned.
The option to extend the Lease allows you to extend the lease term if your restaurant succeeds.
If things don’t go as planned, your total lease commitment has a shorter lease term.
The Truth About Options to Extend Lease
Landlords hate options!
Why?
There is no benefit to the Landlord, and often, the option to extend can lock the Landlord into a lease with below-market rents.
It’s the reason the Landlord will try to sneak in the legal mumbo-jumbo we will explore next.
Options to Extend Lease Have Conditions
For example, you sign a 5-year lease with two 5-year options to extend.
The options to extend the lease grants you the opportunity to extend the term of the Lease. But you must meet certain conditions.
There are many loopholes in the standard Lease and option to extend clause that can either:
- Void the option to extend
- Make the terms financially unacceptable for the restaurant
6 Important Option to Extend Lease Clauses You Need to Understand
Let’s dive into a typical Option to Extend clause.
I have included just a few paragraphs of a Lease Agreement and an Option to Extend the Lease.
The first clause provides the number and length of term for each option.
Option Periods
The following is pretty straight forward.
The Tenant shall have the option to extend the Lease Term hereof for one (1) additional period of sixty (60) months (hereinafter “Option Period”), subject to the Tenant’s compliance with the conditions outlined in this section.
The paragraph above provides for one five (5) year option to extend the Lease.
The next clause to understand is the notice requirement.
Notice Requirement
The tenant may exercise each option by giving Landlord written notice of its intent to exercise the said option, such notice to be received by Landlord at least twelve (12) months before the expiration of the original Lease Term, or a previous Option Period (“Notice Period”).
The paragraph above states that you must provide notice to extend the Lease at least 12 months before the expiration of the original lease term.
Why does this matter?
It’s difficult to make business decisions a year in advance.
For example, if you are considering a sale within the next few years, you may need to extend the Lease to sell the business.
If you exercise the option a year in advance and decide not to sell, you will be liable for another five years.
The notice date should be closer to the expiration of the original lease term.
For example:
To exercise an option to extend, the Tenant must give written notice of such election to the Landlord.
The Landlord must receive the same at least four but not more than six months before the date that the option period would commence, time being of the essence.
If proper notification of an option’s exercise is not given or received, such option shall automatically expire.
Let’s continue.
Conditions Precedent to Exercise of Options
At the time of exercise, Tenant (i) is not in Default, and (ii) is operating a business in the Leased Premises per the Permitted Use.
The paragraph above is vague and could cause problems down the road.
Although the definition of a default is in the body of the Lease, this paragraph should be specific to certain types of default, such as a monetary default.
There should be a period for the Tenant to cure the default before losing their right to exercise the option.
For example, if you were late one time paying the rent, you should not lose your option to extend.
The next clause deals with the rent if you exercise your option to extend the Lease.
Base Rent Payable During First Option Period
During the Option Period, all other terms and conditions of this Lease shall remain unchanged and apply except that the minimum rent shall be the then-prevailing fair market value for the use of the Leased Premises during the Option Period (“Fair Rental Value. Notwithstanding anything to the contrary contained herein, in no event shall the Fair Rental Value be less than one hundred five percent (105%) of the Minimum Rent due and payable for the last Lease Year of the First Option Term (the “Renewal Floor”).
The paragraph above states the rent will be “Fair Market Value”.
Also, it states in no event shall the rent be less than 105% of the rent during the last year of the Lease.
In essence, this clause states that the rent has no chance of going down if the real estate market plummets, but every chance of going up at least 105%.
How do You Determine Fair Market Rent?
In this situation, both parties will hire an appraiser or qualified brokers to determine the market value.
They will often have a third appraiser or broker determine which appraisal is closest to market value and use that valuation.
This process would be fair if there were not a floor of 105% on the rent increase.
Whenever possible, you should negotiate the Option Rent in advance. Hence, you know your rent exposure and plan if it makes sense to exercise the option or let the Lease expire.
Be sure to have the right not to exercise the option if you can’t agree on rent.
Two Risky Option to Extend Mistakes Almost All Restaurateurs Make
Most restaurateurs don’t realize the Option to Extend’s importance until they decide to sell the business and assign the Lease.
- You cannot assign an option to a buyer
- Personal guaranty.
Your Option is Personal (Why it Matters)
This Option is personal to the original Tenant, and cannot be assigned or exercised by anyone other than said original Tenant and only while the original Tenant is in full possession of the Premises and without the intention of after that was assigning or subletting.
Let’s assume you signed a 5-year lease with a 5-year option to extend.
You have been in the space for just over four years and decide to sell.
You think great, and I have a 6-year term remaining that the buyer can assume.
You list the business with a restaurant broker to sell the business.
Suppose the broker is not a savvy restaurant real estate advisor.
In that case, you soon learn that the Option to Extend is void, and you only have one year remaining on the Lease.
You soon learn your business has no value.
If an experienced restaurant real estate advisor and or an attorney specializing in commercial lease agreements, they would have noticed this little clause hidden in the Lease.
Worst case scenario, you cannot sell the business. You will either close the business or risk signing a new lease to sell at a later date.
In the best-case scenario, the Landlord will agree to allow the Option to Extend Lease to be assigned. Still, he will require a substantial payment from you.
Personal Guaranty
Most restaurant leases will include a personal guaranty unless you are a large corporate chain with strong financials.
In the event of a lease assignment, the assignor (you) often remains liable for the Lease after the assignment.
If the assignee (buyer) defaults on the Lease in the future, the Landlord has the right to pursue damages from you.
The buyer’s default becomes an even bigger issue if the guaranty includes the option periods.
For example, suppose you sell a restaurant. The new owner exercises an option to extend the Lease and still have a personal guaranty.
In that case, you will remain liable if the Tenant does not pay rent during the lease extension.
It’s essential to negotiate that upon any Lease assignment, or if you exercise an Option to Extend, the guaranty becomes void.
Summary
Now you know the 6 Little Known Factors About Options to Extend Your Lease that Can Kill Your Restaurant Business.
You will be able to negotiate a lease that protects your long-term interests.
By carefully following the tips below, you’ll be well on your way.
- The Option to Extend grants you the option to extend the Lease
- The notice period should be as close to your lease expiration as possible
- If you default but cure the default, the Option to Extend should not be void
- You should negotiate a rental rate for the Option to Extend in advance if possible
- You should have the right not to exercise the Option to Extend if you disagree with the Fair Market Rent after the appraisal process
- You should make sure the Option to Extend is not personal to the original Tenant
- You should include language so a personal guaranty will become void upon lease assignment and upon exercise of the Option to Extend
Lease negotiations are often hectic as you have many moving pieces to deal with at once.
Often you are focused on the near-term deal points such as rent and how much time you have to build out your store before paying rent.
It’s essential to think about worst-case scenarios, exit strategies, and the fine print.
Many restaurateurs have no issue spending thousands of dollars on a new sign or remodel but balk at spending a few thousand dollars to protect their investment.
This decision can be the difference between a walk down the yellow brick road or the boulevard of broken dreams.
Before signing a Lease, it is highly advised you retain an experienced restaurant real estate advisor and attorney specializing in commercial.
Lease agreements to protect yourself.
Lease agreements are involved.
This article is a great start.
I recommend you read more about how to lease a restaurant to fully understand how your Lease can make or break your restaurant.
Do you need a restaurant real estate advisor or an attorney specializing in commercial Lease agreements?
Shoot me a message, and we will connect you with a professional in your area.
