Growth can be hard to project. New rounds of funding, significant contracts, new products, acquisitions, and mergers can bring rapid growth. Sometimes this growth happens in the middle of a lease commitment. In situations like this, having the right to expand your space can be extremely valuable.
Generally, there are two ways to go about expansion rights in Ottawa leases – there’s a ‘Right of First Offer’ (ROFO), and there’s a ‘Right of First Refusal’ (ROFR). Although they both can give you the right to expand, they can be very different and are often confused.
The ROFO
When you have a Right of First Offer, your landlord is obligated to notify you if a space is becoming available. Then your landlord has to offer you the space on the terms and conditions they’ll be trying to lease the space to other prospective tenants.
Once you receive notice that space is becoming available, you have a set amount of time, typically five to ten days, that you have to agree to lease the space.
If you fail to notify your landlord that you’ll lease the space, then your ROFO expires, and your landlord can lease the space to another tenant. Even if your landlord has to reduce the rent to lease the space to another tenant, they have no obligation to offer the improved leasing terms to you and are free to lease the space to someone else.
The ROFR
Unlike a ROFO, if you have a Right of First Refusal, the landlord is free to market the space to other prospective tenants; however, when the landlord reaches an agreement with another tenant, they have to disclose the terms and conditions of the deal they have negotiated with you. Then you have the right to lease the space on the same terms and conditions that were negotiated with the prospective tenant. You are getting the “last look” at any incoming offer for the space, and you have the right to match the offer.
ROFO vs. ROFR
So, let’s say you have an existing lease for roughly 8,000 sq. ft. of office space and 2,000 sq. ft. of space adjacent to your Suite is coming available.
You have a ROFO, so your landlord offers you the space at their posted rent and terms of $18 Net per sq. ft., with a $20.00 per sq. ft. allowance, and a five-year lease term. Based on the notice period of your ROFO, you have to notify your landlord if you want to lease the space on those terms within five business days.
You do the arithmetic and realize that the $18 Net is more than you are paying now, and the renovations you would have to do on the expansion space won’t be covered by the $20.00 per sq. ft. allowance. So, you decline the space, your ROFO expires, and your landlord is free to lease the space to another tenant.
Now, if you have a ROFR, you can sit back and wait to exercise your right to lease that 2,000 sq. ft. vacancy until there is another offer. So, your landlord markets the space diligently, conducts tours, and sends out a few leasing proposals to prospective tenants, and nothing materializes.
Finally, eight months after your landlord started marketing the space, they receive an offer, and negotiate the terms. The prospective tenant manages to conditionally lease the space at a Net rent of $16.00 per sq. ft., with a $30.00 per sq. ft. allowance for a five-year lease term.
Because you have a right of first refusal, you have the right to lease the space on these improved leasing terms, and you didn’t have to make any decisions for the eight months it took your landlord to find a new tenant.
Landlord’s Don’t Like Them
As I am sure you have concluded, a ROFR gives you far more control over your potential expansion. The issue is that it creates problems for landlords – so they loathe giving them.
ROFR’s seriously encumber a landlord’s ability to lease space. Imagine if you find the perfect space but are told by the landlord that it’s subject to a neighbouring tenant’s ROFR. How likely are you to spend the time and energy negotiating leasing terms only to have those terms offered to another tenant first? Like most tenants, you would probably move on to another option.
Competitive Leverage Required
Whether it is a ROFR or a ROFO, you are going to need some competitive negotiating leverage to get expansion rights into your lease. But if you need more space during your lease term, expansion rights can be valuable and certainly worth pushing for.
Have a question about expansion rights? Send me an email at jeff.daniels@royallepagecommercial.com.
