Purchase Option Is Valid During Renewal Term

An option to renew the lease is a popular tenant inducement—and one you often must offer in an unfavorable market. A typical renewal option clause says that the lease will be renewed on the “same terms and conditions” as in the original lease, with only the rent payments and the expiration date to be adjusted during the renewal term.

But suppose you also give the tenant certain other options or concessions—such as three months of free rent, a $10 per square foot tenant improvement allowance (TIA), a refurbished HVAC unit, and a new sign. And you want these other options and concessions to be available to the tenant only during the initial lease term. With a typical renewal option clause, you'll end up having to give the tenant a renewal lease that makes those other options and concessions available to the tenant during the renewal term, too, warns property manager Richard F. Muhlebach. As a result, you'll be powerless to stop the tenant from, say, demanding another three months of free rent, $10 per square foot TIA, a refurbished HVAC unit, and a new sign during the renewal term—which could hurt your building (or center) and its cash flow, he adds.

A Nebraska owner learned that lesson the hard way. Its lease gave a tenant the option to renew for five years “upon the same terms and conditions as are provided herein.” The tenant exercised the renewal option and then tried to exercise a purchase option in the original lease. The owner objected, arguing that the purchase option wasn't valid during the renewal term. The tenant asked the court to allow it to exercise the purchase option.

The Nebraska Supreme Court ruled that the purchase option was valid during the renewal term, so the tenant could exercise it. The court said that when a lease gives a tenant a purchase option and the lease is renewed on “the same terms and conditions,” the purchase option is also extended for the renewal term, unless the lease specifically says otherwise. The court pointed out that the purchase option clause originally had language limiting the option to the initial lease term—but the parties crossed it out. “This left a purchase option explicitly extended during the renewal term,” said the court [III Lounge, Inc. v. Gaines].

Follow Two Steps to Impose Limits

To protect yourself if you decide to use “the same terms and conditions” language in your renewal option clause, follow these two steps:

1: Review lease. Carefully review the lease and create a list of every tenant option and concession that you want to limit to the initial lease term, says Muhlebach.

2: Add list to renewal option clause. In the renewal option clause, say that certain options and concessions will be available to the tenant only during the initial lease term—then list them. Use the list that you created in Step #1, advises Ohio attorney Abraham Lieberman.

Here's an example from Lieberman of the language you could use and the options and concessions you might include:

Model Lease Language

The following options and concessions shall be available to Tenant only during the original term of this Lease:

a. The right of [insert type of right, e.g., termination] under Clause [insert # of performance kickout clause] of this Lease;

b. The [insert concessions, e.g., rent abatement and tenant improvement allowance], under Clauses [insert #s], respectively, of this Lease; and

c. The option to [insert type of option, e.g., expand the space] under Clause [insert #] of this Lease.

Practical Pointer: Instead of putting this list in the renewal option clause, you could add language to each clause that grants an option or concession you want to limit, says Lieberman. For example, you could say in the expansion option clause: “This Expansion Option shall be available only during the original term of this Lease,” notes Lieberman.

CLLI Sources

Abraham Lieberman, Esq.: Member, Baumgartner & O'Toole, 5455 Detroit Rd., Sheffield Village, OH 44054; (440) 930-4001; alieberman@b-olaw.com.

Richard F. Muhlebach, CPM, RPA: Senior Managing Director, Kennedy Wilson Properties, 275 118th Ave., Ste. 105, Bellevue, WA 98005; (425) 453-2500, rmuhlebach@KennedyWilson.com.