The Devil is in the details: Commercial real estate leasing

This article, written by attorney Eric Kilchenstein, was originally published by and can be found here.

As a commercial real estate and business law attorney, I see a wide array of business models and strategies when it comes to leasing vs. buying commercial space. With some exceptions, larger businesses often lease, no matter the state of the real estate market, while many medium and smaller businesses want to buy their space. For many businesses, like people, the choice of whether to lease or purchase property is circumstantial and often seems understandably tied to the perception, and resultant psychology, of the state of the real estate market.

As with people’s reaction to the stock market, often businesses seem to be of the mindset that they must fall in with the tides and jump in at all costs to buy as the market rises or avoid purchase at the first sign of the market leveling out. Like most things in life, the answer is really more nuanced and more dependent on situational specifics than the ebbs and flows of the market. That said, one thing that is almost always overlooked are the variety of options that can be drafted into a commercial lease to keep the door open for purchasing the company’s leased space.

Every business person responsible for their company’s real estate seemingly knows or is aware of the basic terminology involved with commercial lease provisions related to buying their leased property and virtually all have heard of and know to consider an “Option to Purchase” or a “Right of First Refusal.” Unfortunately, I find that not only are few aware of the distinction between these terms but also of the wide variety of options that can be carefully drafted into their commercial lease so that their company can purchase their leased property at terms that make sound business sense.

There are, in fact, many ways to draft some stripe of purchase rights into a commercial lease.  The three main operative ways are: 1) an “Option to Purchase,” 2) a Right of First Refusal (“ROFR”) and 3) a Right of First Offer (“ROFO”).  As mentioned, these are the basics and within these three there are a wide variety of ways that each can be written but for the purposes of this article I will stick to the basics.

Generally, an Option to Purchase is narrowly written to give the tenant the opportunity to purchase a property on or after a certain date.  As with all leasing matters, and particularly this provision, an Option to Purchase provision should provide as much detail as possible. Too often I see Option to Purchase provisions that do not include enough specificity to achieve what either the commercial tenant or the commercial landlord is seeking to achieve.  Simply stating that there is an Option to Purchase at a certain date is not enough.  A notice clause that includes timing, as with the other two provisions, should be included. Moreover, and perhaps most importantly, great care needs to be taken with describing how the value will be determined. Unless the commercial landlord unilaterally wants to set the price at the time that the Option to Purchase gives rise, a meeting of the minds should occur on price and the clause should include a way to ensure that the purchase price is justifiable to both parties.

Often mistakenly used interchangeably, A ROFR and a ROFO are generally more simple.  That said, they also need to be carefully written and considered with the help of your attorney as the details greatly matter with both clauses. A ROFR is generally triggered when the commercial landlord receives an offer to purchase the property which gives the holder of the ROFR (the commercial tenant) the right to purchase the property upon the same terms as the offer or upon other terms that are listed in the ROFR.  A ROFO is less known as a term but is often used interchangeably and incorrectly with a ROFR.  A ROFO is triggered when the commercial landlord decides to sell the property and gives the holder (the commercial tenant) the right to make a first offer. As with an Option to Purchase, a good amount of detail needs to be provided in a ROFO as to the arrival at the determination of the purchase price.

Whether it be an Option to Purchase, a Right of First Refusal, a Right of First Offer or some modified hybrid of any of the three, all three provisions can and should be written with your company’s particular long-term objectives in mind. While a commercial landlord’s amenability to the terms of your company purchasing the commercial property may not be controllable, your company’s positioning to react to the landlord is more malleable than is often realized. With care and consideration, the terms of purchasing your leased property can often be substantially more palatable to both the commercial tenant and the commercial landlord than is often realized.

With purchase clauses in a commercial lease, and all included terms in a commercial lease in general, take your time, roll up your sleeves, consult a commercial real estate attorney and dig into the specifics. In a commercial lease the devil is truly in the details and being detailed now will infinitely better position your business in the future.