Smith Commercial R.E.
This column is offered to help educate agents new to commercial and investment brokerage and serve as a review of basics for existing practitioners.
When a landlord gives a tenant an option, they make a commitment to honor that option if it is exercised by the tenant. The tenant has a choice to exercise the option or not.
Option to
Extend or Renew
A lease may be written for a specific term and have an option for the tenant to extend the lease term for an additional period, or periods of time (i.e. the term of the lease is five years with a five year option to renew). If the tenant does not exercise the option to extend the lease, the lease ends at the end of the initial term. The rent may be pre-defined for any option period, or determined by a formula, or negotiated at the time each option is exercised. Another method for calculating option rents is the dual appraisal. This takes into consideration current market conditions and values. The landlord and the tenant each obtain an appraisal of rental value and use this to negotiate a rate.
Expansion Option
A tenant may anticipate that their business will grow and they will need more space in the future. They may negotiate an expansion option or a first opportunity clause in their lease. If more space becomes available in the building, the landlord must give this tenant the first opportunity to rent that space.
Option to Buy
In a lease, a tenant may have an “option to buy” the property. This is usually for a specific time period and may be for a pre-determined price. A tenant may want to lease the space first, before making a commitment to buy; to be sure their business will do well in this location.
Purchase Option
When a tenant is given a long period of time or the entire lease term to consider buying the building, this is called a purchase option. The price in not predetermined; rather if the tenant exercises their option to buy a dual appraisal method would be used to determine the sale price. The landlord and the tenant each obtain an appraisal of market value and use this to negotiate a rate.
Right of First Refusal
Another form of an option to purchase is known as a right of first refusal. In this case if the owner decides to sell the property, a tenant with a right of first refusal would have the opportunity to match a purchase offer from a third party and buy the property.
Brokers must be careful that their listing agreements cover all these possibilities. With the right of first refusal, your agreement must state that if a tenant in the building buys the property based upon an offer from your customer, that you are entitled to a full commission. You must also disclose to your customers if someone has a right of first refusal to the property.
Sales Option
When a property is on the market for sale a potential buyer may obtain a sales option from the owner. Effectively the buyer is buying the right to purchase the property within a specific period of time. The owner is being compensated for taking the property off the market and not selling it to anyone else during this time period.
For example a sales option could be used when a property is desired for a use that will require a change of zoning. In some areas the procedure could take a long time. An owner may not want to sell their property “subject to” zoning approval and have to wait to close on it. A sales option would compensate the seller for taking the property off the market and give the buyer time to obtain their approvals. The monies paid for the sales option are fully earned by the owner. At the end of the option period the buyer must close on the property or the agreement to purchase ends. Frequently, if the buyer goes forward with the purchase the monies paid for the sales option will be credited towards the sale price.
Getting Paid
Agents need to have all of these possibilities defined in their listing agreements to receive commission if any of these options are exercised.
Edward Smith, Jr., CREI, ITI, CIC, GREEN, MICP, CNE, is a commercial real estate consultant, instructor and broker at Smith Commercial Real Estate, Sandy Hook, CT.
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