One of the most common areas where lessees slip up with their lease portfolios is not correctly exercising lease options. They can be tricky and ensuring you have a system and process in place to make sure that these critical dates are not missed is key.
In this blog post, we will ensure lease options are explained correctly and provide you with some information on how to effectively put together a system to ensure these critical lease dates are not missed.
What is an option?
An option is the right granted under a lease whereby the lessor grants the lessee the right (but not the obligation) to enter into further lease terms of the premises after the expiry of the initial lease term.
When should you exercise a lease option?
In Australia, the responsibility for exercising a lease option correctly always falls on the lessee, as the lessee receives the benefit of a new lease and burdens the lessor.
So, when should you, as the lessee, be notifying the lessor of your intent to exercise the option? Within each lease that contains an option period, there will be an option clause that will state the specific time frame in which you have to exercise it. This is called an option exercise window.
The example clause below shows that the option exercise window is between nine and three months before the expiry of the initial lease term, giving the lessee six months to notify the lessor of their intent to exercise the option.
However, it is very important that you check each of your leases to determine exactly what each one stipulates as the correct option exercise window.
The example below best illustrates an option exercise window. A lease has a commencement date of 01/07/2005 and expires on 30/06/2010 with a five-year option. The lease calls for the option to be exercised between six and three months from expiry. The areas shown between the arrows is the option exercise window.
What other factors should you consider when exercising lease options?
There are also a few other important factors to consider when exercising options correctly:
- The lessee is not to be in breach of the lease in serving the appropriate notice to exercise the option.
- In the lessee’s option clause, there will generally be directions on what the lessee must do or have done in relation to breaches of lease. A breach of lease, sometimes also referred to as a default, can include a number of factors, the most typical of which is not paying the rent on time or being in arrears.
- There are two important aspects to serving a notice. Firstly, the notice must be unconditional and in writing (i.e. cannot be “I exercise only if x, y, z”). Secondly, the notice must be served correctly in accordance with the directions in the lease under the notice’s clause.
In NSW and QLD, there is a special provision in the Retail Leases Act’s around the exercising of options. The lessee may ask for the option to be determined early, not earlier than six months and no later than three months of the last date in which you can notify your intent to exercise an option.
If this clause is activated, then the lessee has 21 days from the determination notice to decide if they wish to exercise their option.
What happens if you don’t exercise your lease option correctly?
Generally, if a lessee misses their option exercise window, then the option will lapse, unless the lessor agrees to formally extend the option exercise window.
The ramifications of missing the option exercise window could be as drastic as having to close a store, so it is very important to ensure that this option exercise window is not missed, should you intend to exercise the option.
And once the option is exercised?
Once the option has been exercised, the lessee and lessor are locked into that option, neither the lessee nor the lessor can withdraw without penalty as stated in the lease.
How to create a system so you don’t miss options?
Having a system in place to ensure that each lease’s options are correctly exercised is key to ensuring that these important dates are not missed.
Unfortunately, a simple spreadsheet and calendar reminders will not be sufficient with a large portfolio as it is too easy to forget and miss an option. If the person in your organisation who has the calendar reminders set up is away, then you could miss the opportunity to exercise the option.
A system like LeaseInfo’s My Portfolio can assist with ensuring you never miss another critical date again, like options.
My Portfolio has a handy Global Reminders feature that once set up, allows you to create a reminder for key lease dates, including option exercise windows. The feature lets you enter multiple email address to send the reminder to and set reminders for monthly and weekly time frames giving you full flexibility.
It also has the ability to link directly with your Outlook calendar and export all reminders to Excel or CSV.
At LeaseInfo, we recommend all new clients to My Portfolio to set their reminders to be sent to at least three people in their organisation as well as setting them for all critical dates, including option exercise windows, for 12, 9, 6, 3- and 1-month intervals.
This way you will never miss a critical date again!
This post was authored by Simon Fonteyn. Simon is one of Australia’s leading experts in retail, childcare and medical leasing and rental valuations. He holds a Degree in Accounting & Finance, a Diploma of Valuation, a Masters of Management and is an Associate of the Australian Property Institute. With over 25 years experience in the commercial property industry, Simon founded LeaseInfo® as a way to provide more transparency to the industry.