As frequent readers of my column know, most of my commercial real estate practice centers around family owned and family operated manufacturing and logistics companies.
Generally, these legacy businesses are experiencing a transition such as selling the company that leads to a real estate requirement.
Recently, I counseled a family in such a position. They had operated from owned real estate for a number of years. Once the company was sold to a competitor, a family member retained ownership of the building. An option to extend was granted to the occupant which now must be exercised.
Situations like this are far more common than most business owners realize, and they often expose a surprising lack of understanding around options to renew.
An option is not an automatic extension. It is a contractual right that must be exercised precisely and on time. Miss the window and the option may evaporate, leaving the tenant exposed to market forces or, worse, a requirement to vacate.
This brings us to the phrase “time is of the essence.”
In plain English, it means deadlines matter. Very much.
Option notice periods are often narrowly defined, sometimes requiring written notice delivered in a specific manner within a defined time frame. A late notice, an email when certified mail was required, or notice sent to the wrong address can invalidate the option entirely. Courts tend to enforce these provisions strictly.
Equally important is understanding how rent is determined during the option term.
Many options call for rent to be set at market rate. That sounds reasonable until one realizes that market rate is rarely defined with precision. Does it include concessions. Free rent. Tenant improvements. Operating expense structures. Who determines the market rate. Is there an appraisal process. What happens if the parties cannot agree.
Without clarity, market rate can quickly become a source of friction rather than certainty.
Other options rely on CPI based increases.
While these can provide predictability, they also come with nuances. Some leases include caps and floors. A floor ensures the rent increases by at least a minimum amount even in a low inflation environment.
A cap limits how much the rent can increase during periods of high inflation. Both can materially impact the economics of the option term, particularly in today’s volatile economic climate.
There are also practical considerations that are frequently overlooked. Does the option require the tenant to be in full compliance with the lease at the time of exercise.
Even minor defaults can technically disqualify a tenant from exercising an option. Are there personal guarantees that survive into the option term. Do operating expenses reset or continue on the same basis.
In the case I referenced, careful review and timely counsel allowed the family to navigate the option properly and preserve both the tenancy and the value of the real estate. That outcome was far from guaranteed without attention to detail.
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104.
