Negotiating a commercial property termination clause
In the current economic climate, tenants are concerned more than ever about making careful decisions regarding their commitment to expenditures for their business. One of the largest costs to operate a business is the real estate component, whether it’s leasing or owning space. A strategic approach to gain a competitive rate and still have flexibility includes negotiating a termination clause within the lease. This allows the tenant to be released from their financial obligation at a specified period in time with predetermined costs. Landlords are typically willing to agree to a commercial property termination clause provided they are made whole for any costs they incur based on this longer lease term.
4 typical elements factored in to a termination fee
1. The cost of any unamortized tenant improvement allowance
2. The value of any free rent based upon a longer lease term may be reimbursed
3. Percentage of the lease or number of months of rent as a penalty
4. The cost of any unamortized real estate commissions already paid
Often this approach allows a tenant to enjoy the benefits of a longer term lease with the opportunity to cancel the lease prior to the expiration date. An example is structuring terms for a ten year lease with an option to terminate in five years with notification on the 4th anniversary of the commencement date of the lease. Also, a 5 year lease can be structured with an option to cancel after the 3rd year. These termination clauses typically offer the tenant a one-time option to cancel the lease within a specified time frame. If not exercised, the lease remains in full effect until expiration.
Tenants request termination clauses for several reasons. For instance, the tenant may be uncertain of their anticipated growth. By encumbering their company with a long term lease, they limit their ability to expand into a more suitable space. A termination clause allows them to leave their current space and the termination penalty to do so worth paying. A tenant may also negotiate a termination clause if they’re unsure of the future sustaining power of their company. Hence, they feel more comfortable arranging an early exit strategy.
A longer-term lease usually allows for lower monthly or annual leasing costs. However, the benefit to a tenant who negotiates a termination option is they are able to enjoy the rental rates of a long term lease with the flexibility of a short term lease. In the event they exercise their termination option they pay a lower commercial property rent during the term and compensate the landlord at the end of the lease.