Our recent articles addressing commercial lease provisions included discussions about the parties’ relationship, rental provisions and important elements to understand about the “premises.” In this article we address the term of a commercial lease (i.e. the length of the lease), as well as how most landlords and tenants address extensions.
Initial Term of the Commercial Lease.
Although seemingly obvious, the “term” of a commercial lease is an important and sometimes complicated provision. Many leases contain rent-escalations at certain points over the term of the lease and therefore it is important to know exactly when a lease begins and ends. Moreover, because of the ever-changing rental market, it is critical for both tenants and landlords to understand how long a space will be rented by a particular tenant. So, although the “term” of the lease seems like a simple proposition – it should, after all, just refer to a start date and an end date – it may prove more complicated if the parties are not perfectly clear about certain triggering events.
Often, the lease will refer to a “Term Commencement Date” and a “Rent Commencement Date.” The Term Commencement Date is the date upon which the lease actually starts (i.e. the tenant can begin occupying the space). This date is usually triggered upon either (1) a fixed date; (2) a certain event (e.g. the landlord completes certain work); or (3) the date the commercial space is actually delivered to the tenant. The Rent Commencement Date is the date upon which the tenant must start paying rent (and often CAM charges). Usually, the Rent Commencement Date occurs a certain number of days after the Term Commencement Date.
Lease provisions differ as to whether the Term Commencement Date or the Rent Commencement Date are used as the beginning date for determining the overall term of the lease. It is important that while negotiating the lease from the onset, the parties clearly delineate which date is going to be used as the beginning date for the lease term. This should also be clearly established for purposes of any lease extensions. Ultimately, the consummation and termination of a lease will affect the overall length of the lease and, in some situations, may change how rent increases are applied throughout the lease.
Extension of the Commercial Lease.
Toward the end of the initial term, commercial leases usually provide the tenant with the option to extend the lease for an additional term of years. The extension provision should set forth the (1) length of the extension; (2) number of available extensions; and (3) rental amount during the extension(s). The tenant must elect to exercise their right to renew the lease within a specific time period, subject to specific prohibitions on renewal. A common prohibition for renewal is that the tenant has been, or is currently, in default under the lease. Generally, a tenant must give prior written notice of its decision to extend the lease; six to nine months are generally standard in the Boston area.
In some instances, leases may set out a predetermined renewal rental rate. However, the parties commonly prefer to set the rate that the fair market value (“FMV”) to ensure that the future rental amount is reasonable when the extension period begins. Relying on the FMV allows the parties to delay negotiating the renewal rate until the time if/when the tenant elects to renew the lease. FMV may be determined with consideration to tenant improvement allowances or concessions allowed by either party. See our previous article on FMV determination. Commonly, the provision also sets a base amount for minimum rent. For example, the lease may state that the renewal rental rate cannot be set at a rate less than the initial or current rental amount. Extension periods may also be broken up into more than one renewal provision. The initial term of a lease could be set for ten years, with two separate extensions, each for three to five years. This type of arrangement allows both the landlord and tenant to rely on the security of a long-term lease, while still having the option to re-evaluate the lease or end the relationship in a shorter period of time.
Under most circumstances, commercial leases will contain “holdover provisions.” In short, these clauses state that the tenant will pay a dramatic increase in rent (often between 150 and 200%) for the time during which the tenant does not actually renew the lease. This works as an incentive for the tenant to either renew the lease or vacate. Most landlords and tenants ignore this provision at the onset, thinking it is an unlikely scenario. This is a misguided conclusion. Often, landlords and tenants either forget to renew commercial leases or are locked into a dispute about the terms of such a renewal. In either instance, it is advantageous for the landlord to have a clearly delineated increase for a holdover tenant.
The length of a lease, and any options to extend its duration, have benefits and drawbacks for both parties. Landlords may wish to keep lease terms shorter, giving them the ability to move new tenants in at higher rates, particularly when they expect the area or neighborhood to see significant improvements over a short time period. Conversely, a landlord may be more interested in holding on to “anchor” tenants (those whose businesses will pull customers and attention to the building or area) or having the building occupied without the worry of finding new tenants or renegotiating leases. From the tenant’s perspective, they may view longer leases with extension provisions as added security because they cannot be pushed out of a space by another tenant who is willing to pay a higher rental rate or by larger tenants who are looking to expand. However, shorter lease terms may benefit a tenant by giving them flexibility to renegotiate their lease with the landlord or permit them to move to a more attractive location as their business expands. As always when negotiating a lease, the landlord and tenant must independently consider what provisions of the lease are of greatest importance to them and how they can negotiate the terms to work to their advantage.
The above is a simplified summary of different approaches to terms and extensions for a commercial space. Each situation is different, and often different locations will have differing “standards” for how leases are structure. For example, in the Boston area, the standard provisions for commercial leases in Cambridge often differ from those in the Boston. In fact, the standards in different neighborhoods in Cambridge (e.g., Kendall Square) often deviate from other neighborhoods (e.g., Harvard Square). As such, it is critical that both landlords and tenants speak with a commercial leasing attorney before executing a commercial lease.