What follows are our general observations and opinions. It is not legal advice, it is not a definitive statement of California law, and every situation depends on its own facts.
A renewal option looks like the friendliest clause in a commercial lease. The tenant gets the right to stay; the landlord gets a tenant who might. In our experience it is one of the two or three clauses most likely to produce a fight five years after signing, and almost always for the same reason: the option said the renewal rent would be “fair market rent” and said very little about how anyone would work out what that means.
Our view is that an option to renew is only as good as its rent-setting mechanism and its notice mechanics. A tenant with a clearly drafted option and a defined valuation process has a genuinely valuable asset. A tenant with a bare “option to renew at then-prevailing market rate” has something closer to an invitation to negotiate from a weak position, because by the time the option is exercised the tenant has usually spent a great deal of money on improvements it cannot take anywhere else.
Notice: the part that quietly kills more options than valuation ever does
Nearly every option carries a window — typically something like not more than twelve and not less than six months before expiry — during which the tenant must give written notice. Miss it and, on the wording we usually see, the option lapses. Landlords in Los Angeles are not shy about enforcing that, particularly in a rising submarket where the space is now worth considerably more than the option would deliver.
Two drafting points we press for every time we review a lease:
- A notice provision that is achievable in practice. Certified mail to a corporate address that changed two owners ago is a trap. We prefer notice by a method with a real delivery record, sent to an address the lease requires the landlord to keep current.
- A landlord reminder obligation, or at minimum a cure period. Some landlords will agree that the option does not lapse until the landlord has given written notice that the window is closing and the tenant has failed to respond within a stated number of days. It is not a standard term, but we have seen it agreed more often than tenants expect, because a landlord who wants the tenant to stay has no reason to refuse.
We also tell clients to calendar the notice date independently of the lease file, in whatever system the business actually uses. The lease binder is not a reminder system.
How “fair market rent” is supposed to work — and how it goes wrong
A well-drafted fair market rent clause does four things. It defines the comparable set, it says what assumptions apply, it sets a process for resolving disagreement, and it puts a floor or a collar on the outcome. Most leases we review do the first badly, skip the second entirely, handle the third with a single sentence, and omit the fourth.
The comparable set matters more than anything else. In practice a landlord’s appraiser will look at recently signed leases for similar space in the submarket. Whether those comparables are adjusted for tenant improvement allowances, free rent periods and brokerage commissions can move the number ten or fifteen per cent on its own. A renewal tenant usually receives no allowance and no free rent, so comparing the renewal rent to headline rents in deals that carried both overstates the market. We push for language requiring that comparables be adjusted to a net effective basis, and it is worth arguing about.
The assumptions matter almost as much. The clause should say whether the space is valued as improved or as a shell — because if the tenant paid for the build-out, valuing the space as improved means the tenant pays rent on its own capital. That single point is, in our view, the most commonly missed issue in renewal disputes in Los Angeles, and it is particularly acute in creative office and medical space where improvement costs are heavy. Our note on tenant improvement allowances covers how those dollars are treated during the initial term.
Three-broker, baseball arbitration, and what each really does
When the parties cannot agree, the common mechanisms are a three-appraiser or three-broker process, or a form of final-offer arbitration sometimes called baseball arbitration, in which each side submits a number and the decision-maker must pick one of them without splitting the difference.
Our general preference for tenants is final-offer arbitration, for a practical reason: it disciplines both sides. A landlord who submits an unreasonable number risks losing outright, so submitted numbers tend to converge toward something defensible. A conventional three-appraiser process, by contrast, often produces an averaging outcome that rewards whoever opened more aggressively.
Whatever the mechanism, the clause should say who pays, how quickly it must conclude, and — critically — what the rent is in the meantime. A process that takes four months with no interim rent provision leaves both parties guessing. It should also say what happens if the determination comes out above what the tenant will pay: we frequently ask for a right for the tenant to withdraw its exercise of the option within a short window after the number is fixed, which converts a blind commitment into an informed one.
Collars, caps and the practical compromise
The cleanest solution is often to avoid the valuation fight altogether. A renewal rent set at the greater of the last year’s rent and a stated percentage increase, or at market subject to a floor and a ceiling, gives both sides certainty and costs nothing to administer. Landlords resist ceilings, but a collar with a wide band is frequently agreed, and in our experience a wide collar is better for a tenant than an uncapped market reset with a weak process.
One further point that is easy to miss: check whether the option survives an assignment or sublease, and whether it is personal to the original tenant. Many are. A business owner planning to sell the company in five years may find the renewal option — the thing that makes the location saleable — disappears on a change of control. That interacts directly with the assignment and subletting provisions and should be reviewed alongside them.
If you are looking at a renewal now
The useful time to fix a renewal option is before the lease is signed, and the second most useful time is about eighteen months before the notice window opens, when there is still room to negotiate rather than react. If you would like us to read the option and tell you plainly what it is worth, call (310) 556-9692. Commercial lease review and negotiation is transactional work, so we handle it on an hourly or flat-fee basis agreed in advance — not on a contingency.
Related reading: our commercial lease review overview, plus what to negotiate in a letter of intent, CAM charges in a California commercial lease and use clauses and exclusivity provisions.
Again, these are our general views and opinions rather than legal advice or a definitive statement of California law. Reading this page does not create an attorney-client relationship between you and our firm, and every matter turns on its own facts.
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