Your commercial lease agreement may contain an option to renew your lease at the end of the current term. If you choose to exercise your option, you must follow certain procedures. In this article, we look at how to exercise an option to renew and how your rent may be affected.
What is an Option to Renew?
An option to renew is a term contained in a lease agreement. It provides you with the right to extend the lease for a further term. For example, a three-year lease with a three-year option to renew would allow you to extend your lease to six years in total.
These options are not mandatory, but are often included in commercial leases. This is because they provide both landlords and tenants with a greater degree of commercial security.
How to Exercise Your Option
In order to exercise your option to renew correctly, ensure that you have notified your landlord:
- in clear, straightforward writing that you want to exercise your option according to the lease agreement; and
- within the timeframe specified in the lease (the “option exercise window”). There may also be additional deadlines imposed by state or territory legislation.
Once you have taken these steps, your landlord should acknowledge receipt of your decision in writing and begin preparing the new lease document. They can do this via:
- a new lease in the same terms; or
- a deed of extension or deed of extension and variation of lease.
Note that if you are exercising your option to renew for a retail lease, check your state or territory legislation for any additional rules and procedures in place that you must follow.
Market Rent Reviews
A market rent review is one method landlords can use to reassess the rent so that it is in line with the current market value.
The lease agreement will generally set out how the rent review is to be conducted. Usually, the process involves the landlord considering how much rent the tenant would pay for a comparable premises.
However, other methods may also be used, such as:
- an assessment by an independent valuer; or
- by agreement between the landlord and tenant.
When Are Rent Reviews Conducted?
There are no strict rules about when a market review will occur for commercial leases. However, generally a rent review will take place at:
- the time an option is taken up; or
- any time specified in the lease agreement. In this case, rent review may occur after you have exercised your option.
Sometimes, state or territory legislation will allow you to formally request a review of your rent before you exercise your option. For example, the retail leasing legislation in New South Wales and Queensland:
- gives you the right to request a rent review within the three to six month period before the last day you can exercise your option; and
- extends your option period to 21 days after you receive your new rent price.
If a ratchet provision is included in your commercial or retail lease, it may:
- prevent the rent from decreasing, even if the market valuation lowers; or
- limit how much the landlord can reduce the rent.
This means you may not be able to negotiate a lower rent value.
However, in some states this type of clause is prohibited in retail leases. In all states but Queensland, a ratchet clause in your retail lease will be invalid. Queensland retail leasing legislation allows major tenants to agree to ratchet clauses in some circumstances.
Note: Ratchet clauses are not prohibited by state or territory legislation in commercial leases.
You can exercise an option to renew by following the procedure in your lease agreement and abiding by state or territory legislation. If your landlord conducts, or you request, a rent review before the option is exercised, this may alter the value of the rent thereafter.
If you want guidance on how to exercise your option to renew, and whether you can negotiate a rent reduction, call LegalVision’s leasing lawyers on 1300 544 755 or fill out the form on this page.
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