Contraction Rights (Options to Lease Less) in Commercial Leases
Since it’s not always easy to anticipate future business needs, you’ll want to build in flexibility when negotiating a lease with your landlord. In addition to including an expansion rights clause (allowing you to take more space in the building if you need it), you’ll want some flexibility if you end up needing less space than you originally leased—for example, if you decide to outsource certain parts of your business. Whatever the reason you find yourself with empty space, you’ll want to get rid of it and save some money. A contraction option in your lease will give you the flexibility to return some space to the landlord if you need to do so.
You’ll Face Obstacles Negotiating a Contraction Option
Your landlord may interpret your interest in contraction rights as an indication that you’re worried about being overextended—not a good impression to let lie. Try to tread the fine line between optimism and confidence (“My business is solid and my plans are carefully laid out”) and realism (“I’ll need to be able to make adjustments if unforeseen circumstances intervene”).
Even so, most landlords won’t want to give you contraction rights, for purely economic reasons: If you lease less space, you’ll pay less rent. To make a contraction option more palatable, you might get the landlord to agree to a lease clause that:
- only certain business situations will allow you to exercise the contraction right
- you’ll give adequate notice so the landlord will have ample time to re-rent the space, and,
- you’ll turn back only rentable space (that is, an area that’s big enough and configured sensibly to appeal to a new tenant).
You’ll Need Good Reasons for Shrinking Your Space
No savvy landlord will agree to a contraction clause that you can trigger solely to increase your profits. On the other hand, the landlord won’t want your business to be driven under if you can’t reduce your rental obligations—that means no rent at all. That said, you’ll likely get contraction rights only if business necessities make it imperative that you reduce your rent obligation. As you negotiate this clause, think about what dire business changes or downturns are likely to affect your space needs, then propose them to the landlord. The list might include the loss of key contracts which will make your business less profitable; the inability to obtain a patent, which might destroy your market advantage; a sales downturn which requires cutting staff, reducing your space needs; or the need to outsource specific, crucial portions of your business, making it unnecessary to carry unused space.
You’ll Need to Pay for Contraction Rights
Landlords typically charge a flat fee that you pay when you exercise your contraction option. How much is a matter of negotiation. Some landlords will demand a tidy sum and view it as a cushion—if the new rent on the returned space doesn’t match what you were paying, the option fee will make up the difference.
You’ll Need to Give the Landlord Adequate Notice
Landlords who agree to a lease clause giving you the right to return space will want as much lead-time as possible to begin searching for a tenant for that space. For example, you may be required to wait several months between your decision to shrink your space and the date you actually cut back (when your rent goes down). Although a long notice period gives you less ability to respond quickly to business changes, you may have to compromise on this point.
The Space You Return Must Be Usable
The landlord will insist that you return only space that’s usable to another tenant in terms of size and configuration. You may want to describe, in the lease itself, the space you can give up. Presumably, you and your space planner (if any) took this contingency into consideration when you first laid out your area. Besides delivering usable space back to the landlord, you want to be left with space for yourself that won’t require extensive remodeling. If shrinking your space means that new walls or additional entrances are necessary for the next tenant, you’ll need to negotiate these as part of the contraction clause.
Consider Other Options if You Can’t Negotiate a Contraction Lease Clause
Even if your landlord won’t agree to a contraction rights lease clause, keep in mind that there may be other ways to get rid of all or part of space you don’t need. You can:
- simply ask to give up some space (while difficult, this may be possible, especially if the market is hot and you were paying below-market rates)
- terminate the lease (you’ll need a valid reason, such as a lease clause that allows you to terminate if the landlord doesn’t deliver on a crucial promise), or
- rent the space out yourself to someone else, by subleasing or assigning it (assuming your lease allows these options).
This article was excerpted from Negotiate the Best Lease for Your Business by Janet Portman.