Case Studies
Case Study Number 1
“Retail chain loses capped market rent opportunity due to missing the date to exercise their option period…..”
A National, multi-site retailer held a long term lease over a shop of approximately 160 square metres (1,600 square feet) in a small suburban shopping complex which was sold to a prominent property development group.
The tenant had been in the same shop for nearly 5 years and held a 5 year option period which, like many typical retail shop leases, had a “window of opportunity” within which the tenant had the right to exercise its option period (extend the lease for the further 5 year period). In this case the clause in the lease stated that the tenant could exercise its option to extend “no earlier than 3 months prior to the expiry of the initial 5 year term…and no later than 1 month prior to the expiry of the initial 5 year term…”
About 18 months after the property developer had purchased the shopping centre, they had completed a major refurbishment and managed to do this whilst maintaining full trading conditions for about 70% of the tenants who had agreed to remain insitu during the refurbishment works.
The subject retailer had a favorable lease (agreed with the previous landlord) and whilst the rental was reasonable and reflective of the fair market rental for the shop in the former “non refurbished” shopping centre, the refurbishment had significantly improved the centre and the resultant fair market rental had risen sharply.
This would not have been a problem for the subject retailer as, contained within its lease was a clause that preserved their future rental levels with a fixed increase in the event that the tenant exercised its option period. In other words the low rental would have been preserved and the tenant would not have been exposed to a new market rental based on the newly refurbished centre.
Suffice to say that the national retailer failed to exercise its option period during its "window of opportunity" and (as the new property owner was silently waiting in the background !!!) issued with a notification advising that if they wished to remain trading from the shop, they would have to execute a new 5 years lease at current market rental levels, or vacate the shop with 1 month.
The difference in rental from what the tenant would have paid if it had've exercised its option period and what they were forced to pay (i.e. then market levels based on the newly refurbished centre) was AUD $50,000 per annum (or AUD $250,000) over the new 5 year lease.
Case Study Number 2
“International airline misses it's critical date to exercise an option period over 650 square metres (6,500 square feet) of office accommodation. Cost of missing this deadline was in excess of AUD $850,000.00……”
A major international airline held a lease over commercial office premises of approximately 650 square metres (6,500 square feet) in a prestigious high rise office tower in a major Australian capital city.
The company had been a long standing tenant in the building and held a 10 year lease with a 5 year option period to extend the lease.
The option period, like most typical commercial office premise leases, had a “window of opportunity” within which the tenant had the right to exercise its option period (extend the lease for the further 5 year period). In this case the clause stated that they may exercise their option “no earlier than 6 months prior to the expiry of the initial 5 year term…and no later than 3 months prior to the expiry of the initial 5 year term…”
The lease was negotiated at a time when the office leasing market (in the subject capital city) was favorable toward tenants (i.e. there was an oversupply of office space available) and the tenant managed to negotiate a favorable lease commencement rental which was preserved during the lease term by predetermined (and low) fixed percentage increases. The lease also stated that in the event that the tenant exercised its option period the rental would be increased again at the same low fixed percentage increases and would NEVER be subjected to a full “open market review”.
Of course during the first 10 years of the lease, the marketplace in the subject capital city changed significantly and the market rental level for the subject premises was SUBSTANTIALLY higher than that provided for in this particular tenant's lease. This saving would have been preserved if the tenant had REMEMBERED to exercise its option period.
The building owners, knowing that the rental was substantially below market had entered into a new lease with a third party company at new market rentals subject to the incumbent tenant MISSING its window to exercise its option period.
Suffice to say that the international airline failed to exercise its option and were issued with a vacation notice the day after the last opportunity date (i.e. 3 months prior to the expiry of the initial lease term) and were given 3 months to remove their fitout (partitioning, furniture, data cabling, fixtures etc) and to refurbish / makegood the space and relocate to alternate premises.
If that was not costly enough (estimated at some AUD $650,000 for the new fitout alone – the cost of the loss of the below market rental over the 5 year option period is estimated at AUD $65,000 per annum for 5 years) the bigger problem was that the vacancy rate in the subject capital city had fallen to less than 1% and locating an area of 650 square metres (6,500 square feet) and fitting it out and relocating within a period of 3 months was an extremely difficult task.
The total cost of forgetting to exercise the companies option period was in excess of AUD $1,000,000.
Case Study Number 3
“National retailer misses option period on shop lease. Landlord takes advantage of this oversight to force vacant possession to enable redevelopment of the property. Cost to the tenant was in excess of AUD $500,000.00 not including disruption to business and client base…….”
A national retail clothing fashion chain held a 5 year lease with a 5 year option period in an “up market” suburban shopping complex.
The complex was sold to a property developer/investor who had purchased the property with a view to undertake a major refurbishment. They had selected the property, partly due to the short term leases remaining on all but one shop, which held the 5 year option period, although the first initial term was due to expire within 5 months of the developer settling the purchase.
Whether or not the subject tenant was aware that they were the only tenant who held an option, or if they were aware of the new owner's plan is unknown.
The tenant’s lease contained the typical retail shop lease option period clause which allowed the tenant a “window of opportunity” within which the tenant had the right to exercise its option period (extend the lease for the further 5 year period). In this case the clause stated that they may exercise their option “no earlier than 6 months prior to the expiry of the initial 5 year term…and not later than 3 months prior to the expiry of the initial 5 year term…”
The new owner sat silently waiting for the tenant to either exercise its option period and therefore enter into what would have been expensive negotiations to pay the tenant to rescind the lease to enable the development to commence, or for the tenant to miss its opportunity to exercise its option period, thus saving the new owner a considerable amount of money and, in fact, enabling the owner to further profit from the situation by insisting that the tenant either remove its shop fittings and return the shop to its original condition or make a payment to the Lessor in lieu of undertaking such works.
The tenant unfortunately missed the final deadline to exercise its option (i.e. three month prior to the expiry of the initial term) and the next day the Lessor issued a notice to terminate the lease at the expiry date.
The tenant advised the Lessor that they had accidently missed the deadline date and in fact wanted to remain trading from the premises. The Lessor explained that this was impossible and that they would have to vacate as the centre was to be completely redeveloped and it was not possible to do so around existing occupants.
The approximate cost to the tenant was in excess of AUD $500,000 made up of the following expenses and not including any possible costs from the loss of business due to relocation:-
- Payment to Lessor in lieu of removing shop fitting and reinstating the premises;
- The tenant had to undertake a complete fitout of new shop premises;
- Normal relocation expenses, such as leasing and legal fees etc;
- Disruption to business.
