If you have a right of first offer (″ROFO″) on certain space, then the landlord must offer to lease the ROFO space to you before it can be put ″on the market″ for lease.
Most office leases structure ROFOs so that it is the landlord who makes the initial price offer, usually at a pre-negotiated price (e.g., ″at market″). Less frequently, leases may merely require the landlord to advise the tenant that the ROFO space is available and it is the tenant who then makes the initial price offer, which is usually not pre-negotiated. From the tenant’s perspective, the first approach is preferred.
ROFOs offer a growing tenant less assurance that it’ll be able to meet its future space needs than either rights of first refusal or fixed expansion options and ROFOs should be thoroughly negotiated to maximize their utility.
Checklist for negotiating a ROFO
- Do you have a continuous ROFO throughout the term of the lease or for only some portion of the term? Or do you only have a one-time ROFO?
- Do you have a ROFO as to space anywhere in the building? Or only as to space that is in the same elevator bank, the same floor, or contiguous to the original premises? Is the ROFO space specifically identified?
- Length of time you have to accept the landlord’s offer of the ROFO space?
- Do you have the right to inspect the space before having to accept or reject the offer?
- Do you have to take the entire ROFO space being offered or may you take only a portion so long as the remaining space is in a leasable configuration? Are you entitled to elevator lobby exposure or some other favorable configuration so long as you take __% of the offered space?
- If you’re required to take the entire offered ROFO space and you reject the landlord’s offer, is the landlord then required to lease such ROFO space in its entirety to a single 3rd party? If the landlord subsequently offers a sub-divided portion of the ROFO space to a 3rd party is the landlord required to re-offer the smaller space to you?
- Is the landlord to offer the ROFO space to you at __% of the prevailing ″market″ rate, including market concessions and allowances? If you disagree with the landlord’s determination of the ″market″ rate, is there an arbitration procedure? Or is the landlord to offer the ROFO space to you at the then current lease rate for the original premises, along with the concessions and allowances provided for the original premises? Or are such concessions and allowances to be prorated if past the first year of the original lease term? Is the landlord’s offer required to address other pro-rata entitlements and concessions, such as parking?
- If you reject the landlord’s offer and the ROFO space is then leased to a 3rd party, do you retain a pre-emptive ROFO superior to any renewal right contained in the 3rd party’s lease? Is the landlord required to give you advance notice of the approaching expiration of the 3rd party’s lease?
- If the landlord is to offer the ROFO space to you at the rate it intends to offer to 3rd parties, is the landlord precluded from accepting a lower rate from a 3rd party? If the 3rd party negotiates materially better terms, is the landlord required to re-offer the space to you at those terms? Do you have a pre-emptive right to take the space at those better terms?
- If the landlord does not lease the ROFO space to a 3rd party within __ months, must the landlord re-offer the ROFO space to you?
- Length of time you have to review and sign a lease amendment after receipt of same from the landlord?
- If you accept the landlord’s offer of the ROFO space, when does the lease for the ROFO space commence?
- In what condition is the landlord to deliver the ROFO space to you? ″Vacant and ready for commencement of construction of Tenant Improvements″ or ″Substantially Completed″?
- If the tenant improvements for the ROFO space are to be constructed by you, is rent for such ROFO Space abated in full for __ months following the delivery of the space to you?
- If the tenant improvements for the ROFO space are to be constructed by the landlord, is rent for such ROFO Space abated in full for __ days following the delivery of the space to you in order for you to install your furniture, fixtures, and equipment?
- Is the lease term for the ROFO space coterminous with the lease term of the original premises?
- So long as you continue to lease at least __% of the original premises, do you retain your ROFO despite having previously sublet/assigned a portion of the premises?
- So long as there is no material Tenant default that has occurred and continued beyond any applicable notice and grace period, do you retain your ROFO?
- Has Landlord granted other rights to other tenants that will be superior to your ROFO?
- May an assignee or subtenant exercise the ROFO or is it personal to you?
A right of first refusal (″ROFR″) gives you the right to lease additional space on the same terms as those contained in a bona fide offer the landlord is willing to accept from a 3rd party.
A ROFR, however, offers a growing tenant less certainty than a fixed expansion option since the lease does not specify when, if at all, the space is to be made available under the ROFR.
Tenants with negotiating leverage will attempt to supplement their expansion options with ROFRs, while tenants with less leverage, and unable to extract fixed options from the landlord, will look to negotiate ROFRs as a substitute.
Checklist for negotiating a ROFR
- Do you have a continuous ROFR throughout the term of the lease or for only some portion of the lease term? Or do you only have a one-time ROFR?
- Do you have a ROFR as to space anywhere in the building? Or only as to space that is in the same elevator bank, the same floor, or contiguous to the initial premises? Is the ROFR space specifically identified?
- What ″bona fide offer″ from a 3rd party triggers the requirement that you exercise, or not exercise, your ROFR? A written offer, a fully executed letter of intent, a negotiated lease?
- Length of time you have to exercise your ROFR after being presented with the terms of the 3rd party’s offer?
- Do you have the right to inspect the space before having to accept or reject the offer?
- If you reject the landlord’s offer and the ROFR space is then leased to the 3rd party, do you retain a pre-emptive ROFR superior to any renewal right contained in the 3rd party’s lease? Is the landlord required to give you advance notice of the approaching expiration of the 3rd party’s lease?
- Length of time you have to review and sign a lease amendment after receipt of same from the Landlord?
- Must you accept the offered terms, or may you vary them so that the lease term for the ROFR space is coterminous with the lease term of the original premises, but with a prorated reduction in the construction allowance and other concessions? Or is the term of the original lease extended to match the term of the 3rd party ROFR offer? Does the landlord’s offer address other pro-rata entitlements and concessions, such as parking?
- Can you vary the size of the space taken under your ROFR from that which was specified in the landlord’s notice?
- If you exercise your ROFR during the first __ years of your initial lease term, is the per square foot rent for the ROFR space to be at the same rental rate as paid for the rest of your space under the current lease? Or instead, at the rental rate specified in the bona fide offer received by the landlord?
- If you take the ROFR space, do you have the same renewal rights for it that you have for the original premises?
- So long as you continue to lease at least __% of the original premises, do you retain the ROFR despite having previously sublet or assigned a portion of the original premises?
- So long as there is no material Tenant default that has occurred and continued beyond any applicable notice and grace period, do you retain your ROFR?
- Has Landlord granted rights to other tenants that will be superior to your ROFR?
- May your assignee or subtenant exercise the ROFR or is it personal to you?
An expansion option is a tenant’s fixed right (but not obligation) to expand the Premises at a future date. Anchor tenants and other large space users may negotiate a series of expansion options to accommodate planned growth over the term of a lease.
However, Landlords are reluctant to encumber their buildings with expansion options. Vacant space encumbered by a tenant’s expansion space will usually have to be leased to interim tenants at a discount or simply held in inventory by the landlord, awaiting the anchor tenant’s decision as to whether or not it will exercise its option.
Checklist for negotiating an option to expand
- Do you have the right to expand the Premises periodically through the lease term? When will desired spaces in the building become available?
- Is the landlord to deliver the expansion space on a fixed date or within a specified window of time?
- How much prior notice in advance of the option exercise date are you required to provide the landlord? Are you limited as to how early you give notice? Is the landlord required to give you a ″reminder notice″ if you’ve failed to timely provide notice to the landlord?
- May you exercise your Expansion Option at any time prior to the option exercise date if the expansion space is unleased?
- Size of expansion premises fixed or variable within a specified size range? Are pro rata parking privileges increased accordingly?
- Specific space for expansion identified? If so, will the location of the expansion space provide you direct access to the elevator lobby and/or allow you to extend your internal staircase?
- Rent for the expansion space at __% of prevailing ″market rate″ or at then current lease rate?
- If at ″market rate″ and the landlord and you are unable to agree upon the prevailing ″market rate″, is the dispute submitted to expedited arbitration or do you have the right to rescind your exercise of the expansion option? Or is the rent (including any free rent period) for the expansion space to be determined before the expansion option is exercised?
- If the rent for the expansion space is the then current lease rate for the Initial Premises, are concessions and construction allowance received for the Initial Premises to be prorated for the expansion premises or is the expansion space to be delivered ″turn-key″?
- If the rent for the expansion space is at the prevailing ″market rate″ (or a __% thereof), are ″market″ concessions and construction allowances to be provided to you? Or is the expansion construction allowance a function of the allowance received for the initial Premises, as escalated by subsequent increases in a construction cost index?
- Is there a per day penalty if the landlord fails to deliver the expansion space by the required delivery date? May you elect to rescind your exercise of the expansion option if the landlord fail to deliver on time?
- In what condition is the expansion space to be delivered to you? ″Vacant and ready for commencement of construction of Tenant Improvements″ or ″Substantially Completed″?
- If the tenant improvements for the expansion space are to be constructed by you, is rent for such expansion space abated in full for __ months following the delivery of the space to you?
- If the tenant improvements for the expansion space are to be constructed by the landlord, is rent for such expansion space abated in full for __ days following the delivery of the space to you in order for you to install your furniture, fixtures, and equipment?
- Is the lease term for the expansion space coterminous with the lease term of the Initial Premises? Does your right to sublease also apply to the expansion space?
- Does your failure to exercise a prior Expansion Option not affect your right to exercise subsequent Expansion Options? If your right is unaffected and if specific space was identified for each Expansion Option, does the space associated with the prior unexercised option become the next expansion space?
- So long as you continue to lease at least __% of the original Premises, do you retain your Expansion Options despite having previously sublet/assigned a portion of the Premises?
- If you exercise a ROFO or ROFR with respect to any future expansion space for a lease term coterminous with the lease term of the Initial Premises, may you subsequently exercise the Expansion Option associated with such space for other space in the building?
- So long as there is no material ″Tenant Default″ that has occurred and continued beyond any applicable notice and grace period, do you retain your Expansion Option?
- Has the landlord granted other rights to other tenants that will be superior to your expansion right?
- May an assignee or subtenant exercise the Expansion Options or are they personal to you?
When market conditions are soft and favor tenants, an extension option in your lease establishes a baseline for renewal/renegotiation discussions with your landlord. Additionally, a tenant-favorable provision can serve not only as a bargaining chip in negotiations with your current landlord, it can also provide you with price leverage to be used against landlords of competing properties.
Alternatively, when the market is tight and your landlord has the upper hand, a well-structured option to extend can offer you price protection and serve as a ceiling on the rent for the new lease term. It can also preserve your tenancy rights and prevent the landlord from leasing your space out from out under you to a larger tenant or to another tenant willing to pay a higher rent.
Checklist for negotiating an option to extend
- Number of options to extend and the term of each extension period? If multiple options, may they be exercised simultaneously? Is the length of each extension period fixed, or may you specify from pre-determined alternative lengths (e.g., 3 or 5 years)?
- How much prior notice in advance of the option exercise date are you required to provide the landlord? Are you limited as to how early you give notice? Is the landlord required to give you a ″reminder notice″ if you’ve failed to timely provide notice to the landlord?
- Pre-negotiated ″maintenance/repair″ allowance due from the landlord upon exercise of renewal option? If the allowance is unused, is it available as a rent credit?
- Extension term rent at lesser of __% of prevailing ″market rate″ or $__ per rentable square foot? Is extension term rent capped? If the extension option includes an expansion component, is there a free rent period for the design and build-out of any additional space taken?
- Is the ″market rate″ linked to comparable transactions for new, non-renewal tenants? Are the comparable transactions to be in comparable buildings, for comparable space, with tenants of comparable creditworthiness, and for a comparable lease term?
- Is the landlord to provide its ″good faith″ estimate of the prevailing ″market rate″ within __ days after receipt of your notice?
- If the landlord and you are unable to agree upon the prevailing ″market rate″ within __ days, may you elect to either submit the dispute to expedited arbitration or rescind your exercise of the extension option?
- Are the selected arbitrator(s) required to be neutral and not have worked with either party within the prior __ years?
- If you object to the arbitrator(s)’ final determination of the ″market rate,″ may you rescind your exercise of the extension option?
- So long as you continue to lease at least __% of the original Premises, do you retain your Option to Extend despite having previously sublet/assigned a portion of the Premises?
- May you exercise your Option to Extend as to either all or any portion of the then-leased Premises (including any space added to the Premises pursuant to your expansion rights)?
- So long as there is no material “Tenant Default” that has occurred and continued beyond any applicable notice and grace period, do you retain your Option to Extend?
- In those states retaining the common law distinction between an Option to Extend and an Option to Renew, is the correct term used and the required lease terms sufficiently definite?
- Has the landlord granted other rights to other tenants that will be superior to your right to extend the lease term?
- May your assignee or subtenant exercise the options to extend or are they personal to you?
Anchor tenants and other large office users will start the lease planning process well in advance of their lease expiration.
If they’re kicking off construction of a new building or will be taking space that’s currently occupied, they may be signing a lease two or more years before they’re scheduled to take occupancy in the new space. However, subsequent economic uncertainty or business changes may mean that the tenant now needs more (or less) office space than the figure stated in the new lease.
A right to expand or contract the premises before taking occupancy can help such tenants avoid moving into new office space that’s the wrong size on Day One.
Checklist for negotiating pre-move-in expansion and contraction options
- Do you have the right to expand/contract the square footage of the Premises by __ % or __ rentable square feet prior to occupancy? Is this a fixed number or a range?
- Is the location of Pre-Move-In expansion space identified? Is the location of Pre-Move-In contraction space specified?
- When is the outside date for you to exercise your Pre-Move-In right to expand the Premises? When is the outside date to exercise the Pre-Move-In right to contract the Premises?
- When is the due date for you to complete construction drawings for the Pre-Move-In expansion space or, if construction drawings are prepared by the landlord, timeframe for your approval?
- When is the Pre-Move-In expansion space to be delivered to you?
- In what condition is the Pre-Move-In expansion space to be delivered? “Vacant and ready for commencement of construction of Tenant Improvements” or “Substantially Completed”?
- If the tenant improvements for the Pre-Move-In expansion space are to be constructed by you, is the rent for such Expansion Space abated in full for __ months following the delivery of the space to you?
- If the tenant improvements for the Pre-Move-In expansion space are to be constructed by Landlord, is rent for such Pre-Move-In Expansion Space abated in full for __ days following the delivery of the space to you in order for you to install your furniture, fixtures, and equipment?
- Is the Pre-Move-In expansion space to be leased under the same terms and conditions as the balance of the Premises?
- Is there a fee if you exercise your Pre-Move-In contraction right? If so, is the fee limited to the landlord’s actual out-of-pocket costs? Or if the contraction space is a partial floor, does the exercise fee also include an estimate of the landlord’s demising costs? Is there an additional agreed-upon penalty sum added to the fee?
- Has the landlord granted other rights to other tenants that will be superior to your Pre-Move-In expansion right?
A contraction option is a fixed right in your lease to reduce the size of your premises at some future date. You can use it to downsize an office space prior to the lease’s scheduled expiration date.
As you might expect, landlords (and their lenders) vigorously resist giving tenants this right. However, a creditworthy tenant in the market for a reasonable amount of space may be able to extract this concession if the tenant directs its broker to emphasize the issue early in negotiations.
Checklist for negotiating a contraction option
- Do you have the right to contract the Premises periodically through the lease term (i.e., multiple options) or is it a one-time right?
- Is the contraction date variable? Or is it fixed?
- Size of contraction space variable within a specified size range? Or is it fixed?
- How much prior notice in advance of the contraction date are you required to provide the landlord?
- May you identify the particular space when exercising the option? Or is the contraction space specified at the time the lease is signed?
- If you may identify the contraction space when exercising the option, is the landlord’s approval limited to concerns of access, code compliance, and marketable configuration? Or are you limited to giving up a full floor or floors, not a partial floor?
- Is the contraction fee limited to unamortized tenant improvement allowances, commissions, and concessions? Or is there an additional agreed-upon penalty sum added to the fee?
- If the contraction space is a partial floor, are demising costs the landlord’s responsibility? Or does the contraction fee also include an estimate of the landlord’s actual, reasonable, and necessary demising costs?
- Contraction fee due upon exercise of option or at effective date of contraction? If due upon exercise of option, may it be paid in installments?
- Are you compensated by the landlord for any fixtures and the unamortized value of any improvements left behind in the contraction space?
- Is there a pro rata reduction of the amount of any security deposit or letter of credit?
- Are you released from any claims and liabilities relating to the contraction space after the contraction date?
- So long as there is no material Tenant default that has occurred and continued beyond any applicable notice and grace period, do you retain your Contraction Option?
- Are expansion rights, signage rights, exclusivity rights, or other tenant rights impacted by your exercise of the Contraction Option?
- May an assignee or subtenant exercise the Contraction Option or is it personal to you?
As one of the vanguards in environmental sustainability of commercial properties, Australia now imposes significant fines for non-compliance with certain energy efficiency standards. Building owners (and some tenants) whom fail to meet these standards, as of November 1, 2011, face a large financial penalty. This was recently reported in The Sydney Morning Herald.
By contrast in the United States, compliance is generally enforced through incentives by local or state governments. For example, in the City of Chicago a project that is striving for LEED certification will receive their permits on an expedited basis through the City’s Green Permit Program.
While state and local governments in the US have generally followed this “carrot” approach, tenants and landlords should be thinking that the “stick” may not be far behind. That’s particularly the case with so many state and local governments looking for additional revenue sources which, of course, must be balanced against pro-job growth policies.
An office lease is a long term commitment, but the real estate needs of your business are subject to change. Armed with foresight and enjoying maximum leverage (because you were still talking with multiple landlords) you had your broker negotiate a right for you to terminate your lease early.
With a termination option in your lease, you’re ahead of 90% of tenants. Next time, use this checklist to move ahead of the other 10%.
Checklist for negotiating a right to terminate your lease early
- Do you have an ongoing right or the right to terminate the lease at multiple points during through the lease term? Or is it only a one-time right?
- How much prior notice in advance of the termination date are you required to provide Landlord?
- Is the effective date of termination clearly identified as either a specific date or an anniversary of a key date in the lease?
- Is the minimum amount of advance notice required clearly specified as either a specific date or an exact number of days or months prior to the effective date of termination?
- Is the lease termination fee limited to unamortized construction allowances, commissions, and concessions? Or is there an additional penalty, perhaps equal to some portion of the rent to be lost by the landlord during the estimated releasing period, added to the fee?
- If your space has an open, flexible floor-plan conducive to reuse by other tenants, is the lease termination fee lower than it would be if the space has a specialized build-out and thus more difficult to release?
- Is the termination fee due upon the effective termination date, upon the date you actually vacate the Premises, or upon the exercise of the option? If due upon exercise of the option, may the fee be paid in installments?
- Is lender consent or ground lessor consent required in order to terminate your lease?
In office lease negotiations, like most other negotiations, there’s the “sticker price” and the final deal terms. As to the latter, landlords and office brokers frequently talk about comparable lease transactions, a/k/a, “Lease Comps”. Many tenants confuse the reliability of Lease Comps with those of property sales. While Lease Comps may have some validity, they need to be taken with a “grain of salt”. Continue reading →
Responding to the comments from the corporate real estate industry, several weeks ago the joint accounting boards (FASB and IASB) softened their position on some controversial points in their August 2010 draft lease accounting proposal. Two major criticisms of the August 2010 draft were: (1) it would hamper the real estate recovery as many tenants would gravitate toward shorter lease terms which would “throw a curve ball” to the already fragile capital markets; and (2) it would be highly subjective, complex, and administratively burdensome accounting for tenants. Below is a recap of the Boards’ two major changes to their August 2010 draft.
1. Re-classifying leases. Instead of all leases being treated as a finance lease, the Boards have created two types of leases: (1) finance lease – as under the August 2010 Draft; and (2) “other-than-finance” lease. The latter classification was created in recognition that not every lease is a financing transaction. It also addressed the concern that the front-end loaded annual interest expense being amortized would hurt tenants and, in particular those who can least afford it, new businesses. Like the current treatment of operating leases, the “other-than-finance” lease will be straight-lined over the term while recognizing the transaction as a “right to use” asset and corresponding liability.
2. Lease Term to include options on a limited basis. Removing some of the speculation on measuring lease terms with lease options (renewal or termination), options are only considered where there is “significant economic incentive” for them to be exercised. This assessment is made at the commencement of the lease. Unlike the August 2010 draft which would have required continual reassessments of the lease options, the Boards have indicated that a tenant would only need to reassess the lease term when there is a “significant change” in economic factors. Practically speaking, as most renewal options are at “market” (as opposed to predetermined terms), it would seem difficult to state upon entering into a 5 or 10 year lease that there is a “significant economic incentive” for the tenant to renew. Likewise, as a termination fee under most termination options is less than the remaining lease obligation, what determines a “significant economic incentive” to terminate the lease?
While it is refreshing to see that the Boards are listening to the industry and its concerns, it does not seem likely that pendulum will swing fully back to where things are today. Stay tuned….
