The term of the Lease is extremely important to both the value of the Tenant’s business and the value of the Freehold owner’s investment. It is simple – certainty equals value.
The length of a Tenant’s tenure and security will be derived from the Lease. This is extremely important in creating value in a motel business. A Lease which has 5 years left to run is obviously of far less value than one with 20 years left.
Most motel leases will start for a term of twenty-five years (this is usually broken down into an initial term of 10 years, with options for a further five years each).
At the outset, it is important to understand the distinction between “extending” your lease and exercising an option (which is an existing contractual right).
‘Extending” your lease is adding a new right to the existing lease. It is not exercising an existing right under that lease (which is what exercising an option is).
Generally, in a commercial lease, you will find that to exercise an option, the Tenant must give notice to the Landlord within a certain period of time. If the option period is not exercised within the time frame and in the manner specified in the lease then the Tenant will lose their right to exercise the option. It is as simple as that.
However, in a motel, the value of the motel business is linked to the length of the lease and therefore having a clause requiring notice to be given to exercise an option can be risky. We prefer to draft a motel lease so that the options operate automatically – which means that the Landlord has to recognise the options (provided that the Tenant has observed and performed all of the terms of the lease). The Tenant only needs to give notice where the Tenant does not want to exercise the option (which would be rare).
When an option is exercised the further lease will be on the same terms as is in existence, except that the number of option periods will be reduced by one. The rent will generally be reviewed in the same manner as it is every other year. In some cases, the rent may be reviewed to market.
If you do have a lease which requires notice to exercise the option then it is very important that you diarise the dates and exercise the option strictly in accordance with the terms of the lease.
As options are exercised the remaining term of the lease is decreasing and it is worthwhile considering the best time to negotiate adding more time to the end of the Lease – which will “extend” the lease. Often this is done by “buying” further years from the landlord and the best advice is to undertake these negotiations to purchase further years from the Landlord sooner rather than later. Before negotiating with the Landlord, we would recommend seeking advice from your accountant and a specialised valuer in relation to the price per year of extension.