Lease Extension

Lease extension refers to an agreement between the lessor and lessee to extend the tenure of the original lease agreement, along with renegotiated terms in place. In simple words, it can be termed as an addendum to the original lease agreement when the original agreement is about to expire.

Lease extension may not be a necessary requirement for the parties involved in the agreement, but it is important to go for it if one desires to continue with the lease agreement when it is about to reach its expiry. Whether it is a residential property or a commercial property or a vehicle or machinery, this concept of lease extension applies to all kinds of assets.

A lease extension document is concerned with extending the original lease agreement before expiry. Based on requirements, one can take on a lease, a property, home, land, building, car, machines, etc., and the person can enter into a lease agreement for a fixed tenure and premium.

In a scenario wherein both the parties agree, the lessor and lessee shall enter into an extension agreement and pay the respective legal and statutory costs incurred towards extension depending on which process has been followed, formal or informal. And around the lease agreement coming to an end or maybe even halfway through, the lessee may communicate to the lessor about his intention for the lease extension. It can be of a lesser number of years or even the same period as agreed in the original agreement.

A lease is a contractual agreement entered between lessor and lessee. The lessor is the person who owns the property or asset and agrees to lease or rent out that property or asset to a party to earn rental income out of it. Lessee means the person who agrees to take the property or asset from the lessor and is liable to pay a mutually agreed rent for a particular period in exchange for using the said asset.

The above arrangement shall be referred to as the original arrangement/agreement for lease.

Now, when the tenure as per the original lease agreement is near completion, the lessor and lessee may terminate the agreement or go ahead with an extension. When both the parties agree to extend the original lease agreement, the new amended lease agreement is referred to as a Lease extension.

Certain requirements exist to be eligible for the lease extension, specifically for a property. For getting an extension for a house/property, the following three criteria should be fulfilled, namely:

1. The lease required to be extended must be a residential lease. In other words, commercial property is outside the purview of the extension.
2. The original lease must be for at least 21 years; SO, if one is planning to go for an extension, better to make sure well ahead of that the original lease has been granted for a minimum of 21 years.
3. One must have owned the leased property for at least two years; it is important to understand that they may have not necessarily lived for all that time, but they definitely must be the owner of the lease;

Apart from knowing what can make a person eligible for a lease extension, it is also important to note a situation where it is not eligible:

1. In case the property is owned by Crown or National Trust;
2. In case property falls within boundaries of the cathedral;
3. One's ownership in the lease is less than 100%;

One can apply for an extension in either of two possible ways: an informal process or a formal process. Generally, the lease extension process can be through roughly a few weeks to around a year. However, in the case of an informal, the process can be completed way faster.

In the informal process, a person can talk to their lessor, make a reasonably good offer, and once negotiated, go ahead with an extension.

One can probably consider the following points when applying for extension:

• For increasing the value of a property, as properties with long leases are considered more valuable;
• To get a mortgage on the property;
• When one plans to use the property or the asset for longer-term;
• An extended lease term can help in generating higher sale value;
• When one needs to manage the cashflows, e.g., buying a property or asset entails a higher cash outflow. Instead, it would require making only regular payments at fixed periods.

It is possible to go for an extension before the expiry of the original lease agreement. The lessee may communicate to the lessor his intention to go for the lease extension, renegotiate the terms, and the additional period.

Once the terms are communicated and agreed between the parties, an extension agreement should be entered into to give effect to the updated terms and extended lease tenure.

Certain factors need to be considered to arrive at the price of the extension. E.g., factors such as type of lease, the unexpired lease term, current lease value, and ground rent, if any, combined affect the lease extension price.

Apart from the above, there may be costs about valuation to be meted out for the asset/property and legal cost in case a legal expert has been appointed.

The price varies from asset to asset. In other words, the price for an extension for a car may be nominal, a few hundred dollars, whereas the same for a house property may range from a few thousand dollars to even more depending on the case.

Most importantly, it may be noted that to arrive at a price of the extension, various things are to be taken into consideration, along with the type of asset/product being taken off-lease, and there is no one size fits all solution for the same.

Let us consider the following examples to understand how the lease extension calculator works:

Example #1

Steve had entered into a lease agreement with Robert to lease his house for 30 years. At the end of 30 years of the lease tenure, Steve and Robert agree to extend the lease by five years. Such a situation at hand, i.e., the lease extension for an additional five years, is an extension.

It may be worthwhile to note that at the time of lease extension, the terms decided at the original agreement shall be continued or may be changed depending upon the party’s mutual discussion.

Example #2

Rubber Cotton Mills Ltd (‘RCML’) is a company engaged in the business of manufacturing various types of garments. Because fashion and the latest trends keep changing and updating, RCML decided to rent the plant and equipment instead of buying.

Accordingly, RCML entered into a lease agreement with HSEP Inc., a company dealing in machinery and equipment supply for various industries. RCML and HSEP Inc. entered an initial lease agreement for renting equipment for manufacturing garments for a tenure of 5 years. Further, a fixed rental amount of $50000 was to be paid by RCML as a lease payment.

The lease agreement provided details of both the parties, assets taken on lease, payment schedule, and other legal and statutory terms and conditions.

At the end of lease tenure, RCML wished to extend the lease by another 3 years and hence approached HSEP Inc for the lease extension. Post the negotiations between the parties, HSEP Inc granted an extension to RCML for another 3 years at an agreed rental of $52000, keeping all other conditions intact.

A reference is made to the original agreement in a lease extension agreement, and the updated clauses, the extended tenure, and the rent amount are mentioned.

When it comes to leasing, there comes two similar sounding terms – lease extension and lease renewal – which may mistakenly be used interchangeably. This is because for most of the individuals, these two concepts mean the same, but they differ. In a lease agreement, there can either be an extension clause or the clause of renewal, per what and how the landlord wants the agreement clause to contain.

Let us have a look at the differences between the two below:

• In the lease renewal arrangement, the agreement gets renewd for the next lease period and a new lease contract is made. It marks the period between the expiration of one agreement and the beginning of another on, On the contrary, in the lease extension contract settings, there is no new lease agreement involved.
• In the lease renewal settings, the owner of the property, also called the lessor, has the right to renegotiate on the previous contract and have some new terms and clauses added to the new agreement. This new agreement is then signed by the tenants, who wants to use the property further. On the other hand, when the lease is extended, the person taking the property on lease, also called the lessee, extends the lease period, the clauses being continued per the previous contract only.
• When landlords or owners of a property and the tenants decide to renew the contract, it marks the making of an entirely new contract, which leads to the end of the previous contract and activation of the new. When the tenants decide to extend the lease period, it requires updating the previous contract per the modifications in the date.

Based on what are the requirements and expectations of the lessees and lessors in terms of the returns, they can decide whether to choose lease renewal or extension. Once decided, they can discuss and apply the changes to their agreements accordingly.

This article has been a guide to what is Lease Extension. Here, we explain its process, differences with lease renewal, examples, factors, cost & eligibility. You can learn more from the following articles –

• Leveraged Lease
• Ground Lease
• Modified Gross Lease
• Gross Lease