What is a Renewal Option?

A renewal option is a clause in a financial agreement that outlines the terms for renewing or extending an original agreement. The renewal option appears as a covenant in the original agreement and provides specifications under which the entities can renew or extend the original terms for an additional, specified time.

Key Takeaways

  • A renewal option is common in business and rental lease agreements.
  • A renewal option allows for a lease to apply to a specified time period, but the lease can be extended for another term if agreed upon by the participating parties.
  • Renewal options may have specifications or conditions, such as when the lessee must let the landlord know if they will be renewing.

Understanding a Renewal Option

Renewal options are most often found in rental lease agreements. However, they may be included in any type of financial agreement in which it is beneficial for an entity to extend the agreement for a longer term.

A renewal option in a leasing agreement provides the lessee the option, but not the obligation, to renew or extend a lease agreement beyond its initial terms. Lease agreements can apply to both residential and commercial units.

A start-up business may, for example, rent an office space for three years. A renewal option would allow the business to renew or extend the lease to remain in the office space beyond the three-year lease term. This can be beneficial to the business if it is doing well in the location, as it allows the business to remain for an additional term. Without a renewal option, the business could be forced out and another tenet, who possibly offered more money, for example, could be moved in instead.

If the business has been struggling, the renewal option also allows them to close up shop at the end of the initial term without defaulting on the lease and without pressure to renew or extend it.

Generally, the same principles apply for a residential leaseholder. Their term lengths are usually for approximately one year. With a renewal option, a residential lessee can choose to renew or not based on their individual circumstances.

For both residential and commercial leaseholders, it is important to understand the terms of a renewal option and to negotiate for one if it is not originally included in a lease.

In some cases, renewal options may have specific terms that must be followed for renewal. For example, the lessee may be subject to another credit check upon renewal so the lessor knows the lessee is still in good financial shape.

Many leases require the lessee to provide notification of renewal in writing by a specified time prior to the expiration of the original contract. For example, if the lease ends on the last day of June, the lessor may require that the lessee inform them of them desire to renew prior to the end of April (two months notice). If no notice is given the lessor may start looking for another tenant to move in for July 1st, after the original contract ends.

Ensuring that a renewal option is included and abiding by its terms is important for steady and consistent living or working conditions.

Business Renewal Options

Renewal options may also be important to negotiate in business agreements as well. Companies providing goods or services on a regular basis through a third-party agreement may want to include a renewal option in their business agreements to help support long-term work.

Employment and insurance agreements are also cases where a renewal agreement may be important. Some employers may contract with an employee for a specified amount of time with a review and renewal option agreed on in the initial hiring terms. Employment terms may also include the renewal of insurance plans which give the employee the option to renew or change plan terms at specified times. Most individual insurance plans also have renewal options as well.

Example of a Lease Renewal Option

John moves into a new apartment and signs a lease that includes a renewal option. The lease is for one year, and if John wishes to renew the lease for another year he must let his landlord know two months before the lease ends.

For clarity, we will call the end of the lease the expiration date, and the date John needs to notify the landlord that he wants to stay is the renewal cutoff date.

The landlord also agrees to notify John, prior to the renewal cutoff date of any changes in the lease, such as what's included, additional rules, or a change in the cost of the lease. Such changes may require signing a new lease with the updated lease terms, or initialing the old lease with updated terms.

The current lease calls for a $1,500 per month payment, and John is responsible for all utilities. The lease begins on March 1. The landlord has agreed to notify John of any changes in the lease terms prior to January 1, which is the renewal cutoff date. If there are no changes to the terms, and John wants to stay in the apartment, he lets the landlord know, prior to January 1, that he wants to stay under the same terms as before.

John could also say he wants to stay but could ask to revise a few terms. The landlord may agree to these new terms, or not. If new terms are agreed upon, a new lease is signed or the old one is updated and initialed.

If there are no new terms, and John stays in the apartment, the lease with the renewal option continues into perpetuity (unless otherwise stated), until altered or rescinded by either party.