One of the most important clauses to negotiate in a commercial real estate lease is the holdover clause, sometimes called the holdover provision or the holdover rent clause. This clause is important for both landlords and tenants to understand because it prevents the former from re-letting the space while increasing (sometimes significantly) the amount of rent a tenant pays.
In this article, we’ll take a look at how the holdover clause in commercial real estate leases works, and why it’s important for landlords and tenants to care about the clause.
What is a holdover clause?
The holdover clause in a commercial real estate lease generally says that if the tenant stays in the space it is leasing after the lease expires, then the tenant must pay an increased rent above the rental rate at the time of lease expiration.
Rent can vary under a holdover clause in commercial real estate leases
The amount that the rent increases under a holdover clause varies from lease to lease.
Sometimes the increase is by 150%, 200%, or even more. That means that tenants who think they can stay in the space and drag their feet negotiating a new lease will be in for an unpleasant surprise when the next monthly rent statement arrives.
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For example, let’s say a tenant was paying a gross rent of $12 per square foot per year when the lease on a 5,000 square-foot space ended. If the tenant decided to exercise the holdover clause and stay in the space without signing a new lease, the new rent might be $18 or even $24 per square foot.
So, the 5,000 square-foot space that was renting for $5,000 per month when the lease expired now has a holdover rent of between $7,500 and $10,000 per month!
Length of tenancy varies under a holdover clause
The length of time a tenant can holdover and stay in the space also varies depending on how the original lease is written.
For instance, a business renting an office space in New York City might have a holdover clause stating that – following the original agreement’s expiration – the lease becomes month-to-month at the new increased rent. If that happens, the tenant will be required to give proper notice of its intent to move out so that the security deposit isn’t forfeited.
Other holdover clauses may state that the tenant must vacate at the end of the lease, but if it doesn’t the lease becomes month-to-month at the increased rent. A third variation of the holdover clause in a commercial lease may say that the tenant has no right to holdover and that the lease does not become month-to-month, but if the tenant stays it must pay an increased rent amount.
Under these last two scenarios the tenant in operating in a gray area. Even though a significantly higher rent is being paid, if the lease says the tenant must vacate and the tenant refuses to move and holds over, the tenant may be at risk of trespassing on the landlord’s property.
How can tenants protect themselves with a holdover clause?
Tenants should pay close attention to the terms and conditions of the holdover clause when they sit down to negotiate the original commercial lease.
Unfortunately, tenants often don’t give the clause the attention it deserves. It’s not until the lease expires that they find out the hard way what they’re liable for. Extra costs can come from huge rent increase as well as damages caused by the tenant holding over and loss of a new lease to a new tenant.
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Here are four important items a tenant can negotiate into a holdover clause to create a win-win situation for the tenant and the landlord:
#1. Eliminate tenant liability for any loss of rent that results from the landlord not being able to re-lease the space due to a tenant holdover. This is especially important in a hot leasing market where landlords could get more for the space than what the holdover tenant pays, even with a holdover rent increase.
#2. Negotiate a sliding scale for the increase of holdover rent. For example, instead of a 200% holdover rent increase beginning immediately, tenants may ask for an increase to 125% in the first month, 150% in the second month, and so on.
#3. Ensure the holdover rent increase applies only to the ‘base rent’ portion of the tenant rent. In triple net (NNN) leases and modified gross leases, tenants pay a monthly base rent plus extras such as utilities, property tax, building insurance, and common area maintenance expenses. Applying the holdover increase only to the base rent helps keep extra rent expense lower.
#4. Liquidated damages due to the landlord should be part of the holdover rent increase. Sometimes holdover clauses require the tenant to compensate the landlord for damages caused by the holdover in addition to paying a higher holdover rent. By including damages as part of the rent increase the tenant can limit its potential exposure to liability.
Key takeaways
Commercial real estate leases have a lot of negotiable terms and conditions. Accepting the boilerplate language of the holdover clause in a commercial lease can have a big impact when the lease expires and the tenant stays:
- Holdover rent can increase by 150%, 200%, or more;
- Length of tenancy under a holdover clause varies from lease to lease;
- Tenants may find themselves at risk of trespassing under certain holdover clauses.
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