What is 'Lease Extension'
A lease extension is a legal agreement that extends the term of a rental agreement. The lease extension document should name the parties to the agreement, provide the dates on which the extension begins and ends, and reference the earlier agreement that is being extended. Lease payments do not have to remain the same under a lease extension.
BREAKING DOWN 'Lease Extension'
A lease extension could be executed between a landlord and a tenant, when the tenant's lease is about to expire and they want to continue renting the property. Another situation where a lease extension might be desirable is if a consumer is leasing a vehicle from an auto dealership and opts to lease or purchase a different vehicle at the end of the lease term, but wants to temporarily continue using the original leased vehicle because the replacement vehicle is not yet available.
Reasons for Lease Extensions
A lease is a contract requiring the lessee, or the user, to pay the lessor, or owner, for use of an asset for a specified period of time. When the asset being rented is tangible property, it is usually referred to as a rental agreement. For accounting purposes, there are many ways leases can affect balance sheets, making it necessary for businesses to adhere to a standard, which in the United States is set by the Financial Accounting Standards Board (FASB).
Businesses will enter lease agreements, and agree to lease extension agreements, for a variety of reasons. The primary reason for leasing an asset, rather than buying the asset, is risk management. For instance, a business may decide to lease a parcel of land, so that it is is protected from the risk of fluctuations in land prices, allowing the business to focus on its core competency, rather than real estate. Another reason for leasing, rather than owning, a plant, property, or equipment 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 of use for the equipment, but this can be worthwhile if it saves time and cost of selling the equipment at a later date.
Lessees appreciate the option of extending a lease, because this reduces the risk that they will not have access to the plant, property or equipment after the lease expires.