What Is a Lease Extension?

A lease extension refers to a legal agreement that extends the term of an existing lease or rental agreement. Extensions are not a requirement in a business relationship but are often granted just before an original agreement is set to expire. They are common in relationships between landlords and tenants of commercial and residential property, or between parties who lease vehicles, machinery, plants, and equipment.

Key Takeaways

  • A lease extension refers to a legal agreement that extends the term of an existing lease or rental agreement.
  • The lease extension should name the parties involved, the dates on which the extension begins and ends, and should reference the earlier agreement being extended.
  • Lease extensions are common in landlord-tenant relationships, or for the use of vehicles, equipment, machinery, and/or plants.

How Lease Extensions Work

A lease is a contract that requires the lessee, or the user, to pay the lessor, or owner, for use of an asset for a specified period of time. Leases are common for rental properties or for the use of equipment, vehicles, or machinery and plants. When the asset being rented is tangible property, it may also be referred to as a rental agreement.

When a lease expires, both the lessor and the lessee have a few options available. The lessee can vacate or give up access to the property, or the two parties can agree to a lease renewal. This option may require some renegotiation of the terms of the new lease. The final option is to extend the lease. The terms of the original lease are normally still in force, but the time-frame for an extension tends to be shorter. So in the case of a residential rental property, the landlord may keep some of the original lease terms like the rental amount due, but extend the period of tenancy for the lessee.

The lease extension is a formal document that must include certain details. It should name all the parties involved in the agreement, as well as the dates on which the extension begins and ends. The extension document should also reference the earlier agreement being extended. Some lease extensions—especially in real estate—are granted automatically. They may specify a certain length of time for the extension or may allow for the use of the property on a month-to-month basis.

Special Considerations 

Lease extensions are an important part of the lessor-lessee relationship as they reduce the risk involved for each party. For example, a landlord who agrees to a lease extension can keep the original lease terms in tact including any provisions about notices to vacate. This means the tenant has to provide prior written notice before vacating the property. The landlord can rest assured there are no surprises, and won't have to risk an empty unit. Similarly, a lease extension can give tenants some stability. With a proper extension in place, tenants won't have to give up their units after the lease expires.

Although not a requirement, lease extensions reduce the risk involved for both the lessor and the lessee.

Businesses enter lease agreements and agree to lease extension agreements, for a variety of reasons. The primary reason for leasing an asset rather than buying it is risk management. A business may decide to lease a parcel of land, so that it is protected from the risk of fluctuations in land prices. This allows the business to focus on its core competency rather than real estate.

Another reason for leasing is to simplify disposal. A construction company, for instance, may decide to lease a piece of heavy equipment, rather than buy it, so that it does not have to deal with selling the equipment after it is no longer needed. A lessee may pay more per hour in order to use the equipment, but this can be worthwhile if it saves time and the cost of selling the equipment at a later date.

Examples of Lease Extensions

A lease extension may be executed between a landlord and a tenant. In this case, if both parties choose to continue the tenancy, the landlord may issue a lease extension when the original lease is set to expire.

Lease extensions may also be granted to lessees by car dealerships. Let's assume a consumer leases a car for four years. After that period, the lessee may decide to buy or begin another lease for a brand new car. The dealership may grant an extension of the original lease if the new replacement vehicle is not yet available.