Despite being in a legally binding contract, there are situations, especially since the COVID-19 pandemic, where tenants feel forced to terminate their commercial lease agreement early. You may have outgrown your space or it could be time to consolidate locations, or perhaps revenue has changed or operations have evolved—all requiring a different physical location.
While there are some exceptions, early termination of a commercial lease usually comes with penalties and fees. These fees, along with early termination rights, are sometimes negotiated when the lease is signed to legally allow tenants to terminate early. If the lease does not have an early termination clause, the tenant can attempt to negotiate a “lease buyout” instead.
If you’re weighing the option of terminating your lease early, continue reading to ensure it’s the right decision for you.
Should I terminate my commercial lease early?
While the penalties and fees typically tied to an early termination of a long-term lease are not ideal to pay, we recognize that each tenant has its own unique reason for needing to terminate a lease early.
Here are some instances in which you may want to consider early lease termination:
- You’re expanding and need more space. If your business is growing rapidly and the current space no longer suits your needs, it might be time to terminate your lease.
- You’re downsizing and need less space. Instead of paying for excess space, services, and amenities you either no longer need or can’t afford, you may need to leave the lease.
- You’re consolidating your portfolio, or undergoing a merger or acquisition. In each of these scenarios, it may make sense to terminate an existing lease early.
- The landlord is failing to meet expectations. If your landlord has been negligent in upholding its lease obligations, consider negotiating a deal to end the agreement early.
What are the consequences of terminating a commercial lease early?
Many commercial leases do not have pre-negotiated early termination rights. However, when lease termination clauses are negotiated, it’s common for the landlord to require the tenant to pay the landlord’s unamortized costs.
When a tenant signs a long-term lease, the landlord expects to recover its transaction costs (think: tenant improvements, free rent concessions, brokerage commissions), plus interest, over the entire term of the lease. If the tenant chooses to leave the lease early (as outlined in the clause), the tenant agrees to pay the remainder of those costs upon termination.
Can I terminate a lease without penalties?
Some commercial lease agreements, typically in retail centers, include clauses (negotiated as part of the lease transaction) that allow tenants to legally break the contract early without penalty. These clauses include:
- Bailout clause. Allow retail tenants to get out of the lease if your sales are low.
- Co-tenancy clause. Allows you to break your retail lease legally when an anchor tenant leaves, or occupancy drops below a pre-set level.
Here are a few other instances in which a tenant could break a corporate lease legally:
- If your space is in a popular area. Your landlord may agree to early termination if they are able to lease the space again quickly, especially if they can lease it at a higher rate.
- Your landlord breached an important lease provision.
- Your company has claimed bankruptcy.
- You and your landlord agree to terminate early. Enter into a deed of surrender to explicitly release you from all lease obligations.
- You have a permitted transfer and assign the lease to a related entity.
Tips for Negotiating an Early Lease Termination Clause
Like we mentioned earlier, many commercial lease agreements do not include pre-negotiated early termination rights, i.e. an “exit strategy” that allows for the cancellation of a lease prior to its expiration date. But, an early termination clause is important to consider as a tenant entering a long-term commercial lease.
Here are a few tips if you choose to negotiate an early lease termination clause:
- Include your request for specific early termination rights within the initial Request for Proposal and Letter of Intent.
- Determine how early of a notice the tenant must give the landlord before terminating the lease (usually 90 to 180 days prior).
- Outline the landlord’s unamortized costs associated with early termination.
Work With a Trusted Advisor
Ensure that you fully understand the terms of your commercial lease agreement, and seek help as you consider the possibility of early lease termination. Allegro Real Estate Brokers & Advisors can help explain the penalties outlined in your contract and aid your business to make an informed decision.
To discuss your options and learn more about early lease termination, contact an Allegro team member today.