How do lease options work?
A retail lease must include a lease period – the length of time you are renting the shop. It may also include an option to renew or extend the lease. If there is an option, it is an agreement negotiated by the landlord and tenant before entering into the lease.
The option is the tenant’s right to demand another fixed term of the lease on the same terms as the existing lease (except for the rent and length).
Check your lease to find out if you have an option, exactly what you need to do to exercise the option and when it needs to be done. If you want to take up the option, you must tell the landlord in writing before the end of the option period stated in the lease.
An option for an extension of the lease is useful when a tenant isn’t certain how long they want to continue in the premises after the first lease period. If you think you might want to stay, you should make sure you negotiate this with the landlord before signing the lease. This will allow you to lock in again on the same terms if you want to continue your business.
For example, a 'three plus three' option means the first three years are locked in and you can decide later if you want to lock in for another three years. A 'three by three' option refers to a lease of three years, with the choice to have a second three, and then, if the tenant wants it, another three-year lease on the same terms (but usually with the rent changed).
Exercising the option
The option in a lease is nearly always a 'call' option – the tenant has the right to call upon the landlord to give them a new lease, on the terms originally agreed.
You generally must make sure you have met all the obligations of the lease and give the landlord written notice that you are exercising the option in the way the lease says you must give notice.
It’s critical that you exercise the option before the final date for exercising the option. If you exercise it late or incorrectly, it’s likely to be lost and you will have to renegotiate a new lease from a position of weakness.
Download a larger version of exercising the option ((PNG 9.0 KB)) diagram.
The landlord does not have to remind you or send you a notice about the deadline to exercise your option.
Your landlord cannot stop you from exercising the option.
If the option says that the lease changes to current market rent, you can ask the landlord in writing to tell you what the new rent will be. You should send this request to the landlord before the time to exercise the option starts, usually nine to six months before the end of the lease.
If you don’t agree with the new rent the landlord has suggested, you can have a valuer determine it. Valuations can be expensive so make sure there is enough difference in your view of the right rent and the landlord’s view.
Get advice from the Dispute Resolution Unit in the NSW Small Business Commissioner if you are thinking of appointing a valuer.
Once the current market rent is agreed or determined, you have up to 21 days to exercise the option. If you miss the date to exercise the option, you will probably lose the right to the option.
Missing the deadline
If you miss the option deadline, try talking to your landlord as soon as possible about allowing you to have a new lease on the same or similar terms. In many cases, letting you have the option, even if you are late, is easiest for both parties.
Knowing that sometimes you will need the landlord or agent to do you a favour is worth remembering when you think about how you deal with them during the term of the lease.