Existing Superior Rights to Additional Space

Existing Superior Rights to Additional Space

When negotiating a right to additional space (e.g., expansion right or right of first refusal or first offer), tenants should confirm with the landlord that no superior rights exist to the same additional space.  If other rights do exist, those rights will be superior and the tenant’s right will be subject to the existing rights.  Typically, a tenant assumes that its rights are exclusive or superior to any other rights.  That may not be the case.

Read the rest of this blog entry at: http://rrlawaz.com/2011/05/existing-superior-rights-to-additional-space/

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Right of First Refusal / Extension Option (Creating More Renewal Leverage for Tenant)

Right of First Refusal / Extension Option (Creating More Renewal Leverage for Tenant)

I often hear from commercial real estate brokers that renewal options are not that critical during lease negotiations.  Renewal options sound good in theory, but most tenants reach lease renewals by mutual agreement with their landlords and not by exercising an existing renewal option from the lease.  Brokers claim that the value of renewal options for tenants is in leverage for negotiating with the landlord for more favorable renewal terms when it is time to renew.

As discussed in a prior blog entry (https://azleaselaw.wordpress.com/2010/02/08/determination-of-fair-market-rent-part-2-of-2/), methods for determining fair market renewal rent such as appraisals, broker opinions and arbitrations tend to be burdensome, time consuming and expensive.  While tenants may prefer easier methods such as rent adjustments based on CPI or pre-established rates of increase, most landlords are unwilling to agree to these methods because they are generally unfavorable to the landlord in today’s leasing market where rents are considered relatively low (i.e., landlords do not want to be stuck increasing rents based on a number that is artificially low to start).  Further, even with pre-established rates, tenants use the renewal rates as a starting point in negotiations with the landlord and end up reaching a renewal without exercising the renewal option.

Tenants and tenant rep brokers should consider using a right of first refusal for an extension of the term to create additional leverage.  Rights of first refusal are commonly used with respect to expansion (i.e., if the tenant needs more space, it has a right of first refusal on adjacent space).  However, a right of first refusal could be very powerful with respect to lease extension.  To illustrate, when the tenant is in its last year of the lease term, the landlord likely will market the space for lease.  If the landlord obtains an offer from a prospective tenant, the right to match that offer would be valuable to the tenant.  Since a new tenant likely would receive incentives that are not applicable to a continuing tenant (e.g., tenant improvement allowance), the value of the incentives could be amortized over the entire lease term for the existing tenant to achieve the same financial deal.  Even better, the tenant could negotiate for the right to accept the terms of an offer from a new tenant, but at 95% of the offered rental rate.

A right of first refusal for an extension of the term should be negotiated in the letter of intent and included in the lease.

Prior to using any language or concepts from this blog entry, consult with an attorney.

Ryan Rosensteel is a real estate and construction attorney licensed in Arizona.  You can contact him at ryan.rosensteel@azbar.org.

Right of First Refusal / Expansion Option (Limitations Favoring Landlord)

Right of First Refusal / Expansion Option (Limitations Favoring Landlord)

In the current commercial leasing market, tenants are asking for and frequently receiving option rights, including early termination options, renewal options, and expansion options.  Expansion options are most commonly given in the form of a right of first refusal to lease additional adjacent space.  The simplest form of this provision provides that if the landlord receives an offer to lease space adjacent to the tenant’s space (the “Expansion Premises”), the landlord will allow the tenant a reasonable amount of time to consider the offer and the right to lease the Expansion Premises on the same terms as the offer.

One factor that the landlord should negotiate is the length of time given to the tenant to consider the offer.  I have seen tenants ask for a 30 or 60 day period.  With such a long period, the landlord risks losing its offer, as a prospective tenant will not wait 30 or 60 days to find out if its offer is accepted (especially in the current competitive market).  A reasonable amount of time is 5 or 10 business days.  A prospective tenant likely will wait one or two weeks to find out if its offer is accepted, and the current tenant should be able to make a business decision within this period.  If the tenant is a large corporation and requires corporate board approval, a longer time period may be appropriate.  Also, if the tenant leases a large initial space (e.g., 10,000 SF) and the Expansion Premises are relatively small (e.g., 2,500 SF or less), the existing tenant may receive a longer period because it has more overall impact and leverage in the project.

A second factor is the form of offer required for the existing tenant to consider.  The landlord should only be required to enter into a letter of intent with a prospective tenant, and not fully negotiate a lease.  The letter of intent should be delivered to the existing tenant, and the existing tenant can choose to accept those business terms with the form of the lease for the Expansion Premises remaining the same as the original lease.  This prevents the landlord from having to spend time and money fully negotiating a lease with a prospective tenant, only to have the existing tenant accept that offer.

A third factor for the landlord to consider is when the tenant’s right of first refusal is extinguished.  In other words, how many times must the landlord allow the tenant to consider and refuse offers before the tenant no longer has the right.  Ideally for landlord, the landlord only has to offer the Expansion Premises once to the tenant, and if the landlord receives additional offers that are for the same base rent or higher as the initial offer, the landlord would not have to re-offer the Expansion Premises again and again.  The landlord should only have to re-offer the Expansion Premises if the additional offer is for a lower base rent.

Along the same lines as this third factor, the landlord could provide that it will make an original offer to the tenant prior to the landlord marketing the Expansion Premises for lease.  If the tenant refuses that original offer, the landlord is free to lease the Expansion Premises for the same base rent or higher without re-approaching the tenant.  Following is sample language for this type of provision:

At any time during the Term, Landlord shall notify Tenant in writing of any space contiguous to the Premises becoming available for lease and shall propose rent and other lease terms and conditions for the lease of such space, except that the term for such space shall be coterminous with the Term and renewal terms (if any) of this Lease.  Tenant shall have five (5) days following receipt of Landlord’s notice to elect to lease such additional space, which election Tenant shall make in writing to Landlord prior to the end of the 5-day period if Tenant desires to lease the proposed space.  If Tenant does not so elect to rent the additional space within such time period, Landlord may lease the space to another tenant at a rate and on terms and conditions no more favorable than those offered to Tenant.  If Landlord agrees to lease said space to another tenant on terms more favorable than those offered Tenant, Tenant must first be offered the space on the more favorable terms before such space may be leased to the other tenant; provided that, in this situation, Tenant will make its election within five (5) days of receipt of Landlord’s notice of more favorable terms.

I have had landlord clients question this provision as giving the tenant two bites at the apple.  Instead, it should be viewed as a limitation on the landlord’s future obligation to offer the Expansion Space to the tenant.

Finally, a savvy tenant will require that the right of first refusal be restored every 6 or 12 months.  This is a reasonable request, as a tenant’s position on expansion likely changes as time goes on.  The landlord should try to push the restoration of the tenant’s right of first refusal to every 12 months or more.

Prior to using any language or concepts from this blog entry, consult with an attorney.

Ryan Rosensteel is a real estate and construction attorney licensed in Arizona.  You can contact him at ryan.rosensteel@azbar.org.