Now is the Time to Negotiate Better Lease Termination Options
Written By: Chase McAteer
Businesses considering a lease renewal or signing a new commercial lease should now be able to negotiate better lease termination options.
The last few months have been difficult on many levels. Business owners leasing office space in particular are concerned with lease termination options. Plenty of executives wonder about the future of office space. Commercial real estate brokers and agents are having these discussions daily with our clients. Many business owners are simply wonder HOW LONG this will last. For companies that plan on keeping their office space it is an excellent time time to negotiate better lease termination options going forward. Many industries have been negatively affected – this is unsurprising given the 32% quarterly drop in GDP. If your business is stable enough to be long-term minded right now, you should be considering ways to build flexibility into your real estate.
With that in mind here are two ways you can negotiate better lease termination options to maximize flexibility.
1. Get aggressive by adding multiple termination options, and
2. Add contingencies in the event of a government shutdown
Flexible Tenant Termination Options
It has always been a best practice to negotiate a right to terminate your commercial lease. If you’ve worked with a tenant rep broker in the past you are likely familiar with termination options. It may have been important in the past, but today it feels imperative. The economic disruption and uncertainty caused by COVID-19 will likely be here for awhile. Tenants can and should use this as leverage in negotiations with their landlords.
If your commercial office, industrial, or retail lease expires in the next 24 months now is the right time to negotiate better lease termination options.
If you are stuck in a lease with too much remaining term, check out my article on early termination options.
In most cases your landlord will be highly motivated to strike a deal with you. Every deal they can execute during the pandemic is a good deal. Market activity is below 2011 levels, and it is a tenant’s market. If your business is strong enough to weather the downturn and you can commit to a lease, it could be worth it to go forward with a renewal or new lease. So what are some ways to negotiate better lease termination options?
Go Ahead and Get Aggressive
Given the relative strength of the tenant’s position during negotiations, I recommend going for aggressively flexible termination options. Instead of a one-time right to terminate the lease try for an on-going right. This means you have the ability to terminate the lease at anytime by providing notice to the landlord. Instead of a long notification period, try for something very short like 3 months written notice. When you negotiate better lease termination options you can also push back on excessive penalties. You might be able to lock in a penalty in terms of months of rent paid. You should be aiming for 2-3 months of rent to terminate the lease. If this is a renewal and the landlord’s costs for tenant improvements are low, this should be very feasible.
Multiple Options to Terminate the Lease
If the landlord won’t agree to an on-going right to terminate your lease, perhaps you can opt for multiple one-time options. For example, you might have the right to terminate the lease at month 36 and 48 of your 60 month term. The penalty to exercise the option may be lower at month 48 compared to month 36 so keep that in mind. Sometimes the best way to negotiate better lease termination options is to just have more of them!
The bottom line is this: given the extreme disruption and uncertainty in the economy today, tenants which are willing and able to commit to a new lease or lease renewal can afford to be aggressive with their termination rights.
Have a Contingency for Government Shutdowns
The pandemic has taught many of us some memorable lessons this year. In commercial real estate many tenants realized that the Force Majeure clause in their lease will not help them avoid rent payments. They also realized their leases don’t have any protection in the event of government mandated shutdowns. Prior to the COVID-19 pandemic this is not something most landlords would have even considered accepting in a lease agreement. But in our “new normal” environment tenants should be attempting to include this in their leases. There are times when tenants need to negotiate better lease termination options. But there are other times when you just want to avoid paying rent for awhile. Here are some pointers for adding such a provision in your next lease.
1. Add the option to defer rent automatically in the event of a government mandated shutdown. The length of deferment permitted and the specifics of how this event is triggered will come down to the language in the lease. I recommend consulting with a real estate attorney to ensure the provision is drafted properly. The most fair situation would be for the months of deferred rent to be added to the end of the lease agreement. For example, deferring 4 months of rent now might extend a lease set to expire in March until July instead.
2. Add a right to terminate the lease agreement in the event of a government-mandated shutdown. This can be tied to the event (the shutdown) or perhaps to the loss of revenue due to economic impacts. It is common for businesses to be permitted a termination right in situations where a key individual dies or is no longer able to work. This would be similar, but tied to economic circumstances outside the business’ control. Again, consulting with a real estate attorney will ensure the lease reads how you intend it to.
Summary
Companies in a decent financial position may want to consider committing to another long term lease. With the current economic instability and the forecast for decreasing occupancy for commercial properties the landlords may be in a deal-making mood. Take advantage of these conditions to negotiate better lease termination options and more tenant-favorable lease language.