Negotiating a Commercial Lease Buyout
Negotiating a commercial lease buyout is one way for a tenant to get out of a commercial property lease.3 min read
Updated July 7, 2020:
Negotiating a commercial lease buyout is one way for a tenant to get out of a commercial property lease. Depending on the existing contract, getting out of the lease could involve paying a substantial sum of money. However, there are other exit strategies.
Lease Exit Strategies
A weak economy usually leads to shrinking business operations. This results in reduced demand for real estate in the following sectors:
Your exit strategy alternatives will fall into one of the following categories:
- Early termination
- Sublease/assignment/rights transfer
- Lease buyout negotiations
Consider the following important issues before trying to exit a lease early:
- If you can terminate or sublease, which makes the most financial sense?
- If you don't have those options, how can you go after a sublease pursuit or negotiated lease buyout?
- Do you know what kind of research and analysis you'll need to reach the right decision?
Usually, this is the best alternative. If it exists, it will be in an existing lease agreement. Look carefully, as it may be hard to find an early termination clause. These rights are often hidden in less obvious side letters, addenda, or exhibits.
When you locate the rights, carefully review the language to see if it's reasonable in current market conditions. If it is, exercise it according to the lease requirements.
This is a less desirable alternative, but you may wish to apply the sublease/assignment/transfer provision.
For instance, a corporation may consider transferring its obligations to a related entity or another corporate division. If the potential transferee has a credit rating equal to or stronger than the original tenant, the provision may allow a transfer without being subject to landlord consent.
When an entity transfer won't work, carefully study the tenant-friendliness in the contract's language. The landlord will probably have some degree of approval, and it may range from reasonable to arbitrary.
On occasion, a tenant is fortunate enough to earn a profit from assignment or sublease. The tenant may also secure a novation, releasing it of any further obligations.
Commercial lease buyouts are relatively simple and quite easy to understand. A buyout generally occurs when a tenant pays its landlord a substantial sum of money in order to end the lease before it officially concludes. Sometimes, a buyout is outlined in the original lease contract, but other times, tenants agree on it later on. It's usually an expensive option, but you should still consider it.
Use a market study to fully evaluate a lease buyout. This will help you assess basic real estate market supply and demand as well as sublease supply and economics. Once you fully understand local market conditions, reach out to the landlord to determine his position. No matter what market conditions are like, the landlord usually has a contractually strong position.
The main issue you'll have to resolve in a lease buyout is the penalty. In a strong economy, these negotiations can begin with the tenant paying 50 cents on the dollar. In a soft economy, the tenant often pays closer to his remaining rent obligation. This includes a low discount rate to calculate present value.
Market conditions heavily influence the value of a lease buyout, but the landlord's plans for the property and financial situation also influence it. Unfortunately, a tenant won't know about these factors until after contract negotiations begin.
You can certainly consult an attorney to help you structure and document this type of transaction. However, a motivated real estate advisor can play an important role by doing the following:
- Evaluating market conditions
- Conducting comparative financial analysis
- Uncovering landlord motivations
- Facilitating negotiations
The lease buyout agreement should refer to the lease and any amendments. It should also establish an early termination's effective date, the penalty, tenant obligations, and the premise's condition upon vacation.
Commercial tenants have various reasons for wanting to get out of a lease early. It's important to know all of the available options. Fully understanding your lease agreement will go a long way toward knowing your options. Because commercial agreements may be especially complicated, you should always consult with an expert in contract law when entering into such an agreement.
If you need help with negotiating a commercial lease buyout, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.