• Advice to Commercial Tenants: Don't Leave Rent For Renewal Option Open for Later Agreement
  • November 28, 2013 | Author: Robert A. Fuerst
  • Law Firm: Meyers, Roman, Friedberg & Lewis - Cleveland Office
  • If you are leasing space in a commercial building, you likely will want to ask your landlord for an option to renew the lease. Renewal options can be very valuable to tenants because they give tenants flexibility to know that they will not have to move when the initial term of the lease expires if they choose not to. The problem is that landlords, and sometimes tenants, are reluctant to set a definitive rent for the space during the renewal period because they are unsure what the market will be at the time the tenant exercises the renewal option. As a result, landlords sometimes will put a provision in the lease that says that the rent for the renewal term will be, “in an amount to be negotiated,” or “in an amount to be agreed upon by landlord and tenant.”

    Such a provision will not be a problem if the landlord and tenant can agree on a fair renewal rent. But, what happens if they cannot agree? If the initial term expires and the tenant thought he would have the use of the space for another three or five years, he is now faced with the uncertainty of whether he has a valid option and what the rent is going to be. In fact, a renewal option at a rent to be “negotiated” or “agreed upon” is an invitation to litigation, because if the parties cannot agree, they likely will end up in court.

    Most courts that have looked at similar renewal option provisions have found that agreements to renew at a “rent to be negotiated” or “agreed upon” are unenforceable agreements to agree. Courts are generally reluctant to rewrite agreements for parties who fail to specify the important terms of that agreement. Instead, they are likely to find the renewal option unenforceable. A minority of courts have been willing to enforce these provisions, determining that the rent to be agreed upon or negotiated is the fair market rent for the space.

    So, how should option rent be determined if the parties cannot agree on a definitive number for the renewal rent?  The two most common methods to determine the rent are to tie it to an increase in the Consumer Price Index or to use a market rent formula.

    Although the Consumer Price Index will yield a definite amount, it is not necessarily the best method for determining rents, since rents do not necessarily follow the Consumer Price Index. Rent is determined by the forces of supply and demand within the particular rental market, while the Consumer Price Index is based on the prices of housing, food, gasoline and other consumer products unrelated to the commercial real estate market.

    That leaves a market rent formulation as the best method for determining the rent for the renewal option. This, of course, assumes that there is a definable market for the particular space in question. The lease should be specific as to what the market is and what factors are to be considered in determining the market. For example, is the landlord to provide an allowance for remodeling? Is the landlord going to have to pay a broker? Assuming the answer to these questions is “no,” then the market rent for new space should be discounted by the costs of landlord’s allowance and possible broker’s commission. There also needs to be a procedure for determining the market rent if the parties are unable to come to an agreement on what it is. My usual approach is to have the landlord and tenant each appoint a broker who is familiar with the market to make the determination of fair market rent. If the numbers are within 10% of each other, the fair market rent is the average of the two numbers. If there is a greater disparity, the two brokers pick a third broker who uses the baseball arbitration method and picks the number which he thinks is the most reasonable.

    While a market rent provision does require more language than a simple phrase like “rent to be agreed upon,” having a definitive method for determining the rent will save lots of money and aggravation if the parties cannot agree on the rent when the renewal option is exercised.