How Commercial Lease Options Can Help (Not Hurt) Landlords
TL;DR
Lease options are one of the highest-leverage, lowest-input ways to build value in commercial property, and one of the most dangerous if you get the mechanics wrong. Before you have any conversation with a tenant about their option, you need to understand who has the onus to give notice, exactly when the option notice window opens and closes, whether market rent determination is coupled to that window, the vacancy rate and comparable supply in the area, and whether you actually want to keep this tenant. Get the timing wrong and you can lose real leverage. Get the wording wrong and it can cost millions: one word in a lease, “may” instead of “must”, once meant the difference of about $2M in value on a single property.
Watch the video
Watch the full video on YouTube: How Commercial Lease Options Can Help (Not Hurt) Landlords.
The short version
Lease options can generate enormous returns with very little ongoing input, but they are also a place where getting it wrong can cost you the tenant and the income that pays your bank interest. Before entertaining any conversation with a tenant, a landlord needs clarity on a handful of mechanics buried in the lease wording. Who has the onus to give notice on market rent, the landlord or the tenant? Does the landlord lose the right to review market rent if that notice period lapses? Does the market rent determination actually align with the option exercise window, or can they be pulled apart?
Timing is everything. Take a standard structure: a 5-year lease with a 5-year option, and a 6-to-3-month notice window before expiry. If the tenant doesn’t exercise their option inside that window, they lose the right to extend, full stop. That single date can determine the entire negotiation. If market rent sits above passing rent and a tenant misses their window, a landlord is in a strong position: grant a new term, but only with a meaningful rent increase, because the tenant’s alternative is downtime, make-good costs, moving costs and finding a new premises inside a matter of months. If that same conversation happens nine months out instead, the tenant has far more room to negotiate or walk. The earlier a landlord knows the tenant’s intention, the more time there is for a plan B: marketing the space, upgrading it, lining up a new tenant. But too early and the landlord risks locking in a rent before knowing where the market has moved to.
Where possible, I like to uncouple the option exercise from the market rent determination. The option is simply the tenant’s right to stay; market rent is a separate question that can be resolved closer to the actual expiry date, sometimes right up to the day before. That gives the landlord a stronger negotiating position, though tenants understandably prefer knowing their future rent before committing to stay, so it’s worth being upfront that this is a genuine trade-off, not just a technicality.
Before any of these conversations, do the homework. What is the vacancy rate in the area? What comparable stock exists right now if the tenant wanted to leave? Is this tenant actually optimal, or would you welcome a better one at better terms? Is the passing rent above or below market? If passing rent is below market and the tenant lets their option lapse, a landlord who quietly says nothing is often in the strongest position, because the tenant may simply forget and miss their date, especially with businesses of national or global scale, which happens more often than people expect. If passing rent is above market, the dynamic flips and the landlord may prefer to stay quiet for the opposite reason.
None of this is really about being adversarial. The single word difference between a lease clause saying the landlord “may” determine market rent versus “must” determine it once literally meant a $2 million difference in outcome on one property, because “may” meant the landlord could simply choose not to determine a new rent and let the existing rent continue through the option period. That is why reading the lease with total precision, and running scenarios with a lawyer, matters as much as reading the market. Once you understand both, the healthiest approach is usually still to look for a win-win: you’re likely keeping this tenant for years to come, and they remain your biggest investor, covering the outgoings, the bank interest and the income that comes to you.
Where to go from here
Most people start with Cal’s Fortify Your Wealth series, a multi-part video series on the strategies he uses when the market shifts. There are also weekly videos on YouTube.
If you would rather talk it through, book a free intro call with the Investor Code team.
For the full framework, there is the Commercial Property Mastery online course.
Frequently asked questions
What is a commercial lease option?
A commercial lease option gives a tenant the right to extend their lease for a further term, typically within a defined notice window before expiry, for example 6 to 3 months out. If the tenant does not exercise the option within that window, they generally lose the right to extend.
What happens if a tenant misses their option notice period?
The tenant typically loses their legal right to extend on the existing terms. That puts the landlord in a stronger negotiating position, able to offer a new term only with a rent increase, a shorter or longer lease, or better security, since the tenant now faces the cost and disruption of relocating on short notice.
Should a landlord align market rent review with the option exercise date?
Not necessarily. Many landlords prefer to uncouple the two, treating the option purely as the tenant’s right to stay, and leaving the market rent negotiation until closer to the actual expiry. This preserves negotiating leverage, though tenants often prefer certainty on rent before deciding whether to exercise their option.
Why does the wording “may” versus “must” matter in a lease?
Wording that says a landlord “may” determine market rent, rather than “must”, allows the landlord to choose not to reset the rent, letting the existing rent continue through the option period. On one property, that single word was worth roughly $2 million in outcome, which is why lease clauses need to be read with precision.
What should a landlord check before negotiating a lease option?
The vacancy rate and comparable supply in the area, whether the tenant is optimal or replaceable, whether passing rent sits above or below market rent, and the exact wording and timing in the lease around notice periods and market rent determination.
Full transcript
Hey everyone, I’m Cal Doggett, founder of Investor Code, and welcome to this week’s video. I’m going to cover how to navigate lease options like a pro, from the landlord’s perspective. I wanted to cover this because I get so many questions about it in my online course, and it’s an area where, if you master it, you can make incredible amounts of money with very little input, but huge leverage. It’s also an area fraught with danger if you get it wrong, you could lose your tenant, lose your income, and be unable to pay your interest to the bank. So I can’t cover everything, but I’ll show you a few key things to think about and how to structure these negotiations in the healthiest way.
Why listen to me? Twenty years of commercial property investing experience, well over half a billion dollars of property transacted, closer to $550 million now. Well over 100 leasing deals, probably closer to 200 by the time you’re watching this. My syndicated business has produced a return of over 21% per annum on average, and I’ve never lost a dollar, with the lowest return we’ve ever offered sitting at 6%. What I’m most proud of is that with private clients and personally, I’ve generated returns well over 100%, sometimes 200%, by knowing where to spend my energy and time. I cover that in my six-step framework in the online course, and lease options are a huge part of one of the three key actions I take on every acquisition.
Let’s dive into a theoretical option. Assume a 5-year lease with a 5-year option, a 6-to-3-month notice window, and critically, that market rent is above passing rent. If it were the reverse, passing above market, I’d want a very different outcome. There are some critical things you want to understand, mostly contained in the lease wording. First, who has the onus to provide notice of market rent, the landlord or the tenant? Second, does the landlord lose the right to review market rent once the notice period lapses? If your lease is well worded, you don’t lose that right even after the date passes. Third, does the market rent determination actually align with the option notice period, or can it happen later, right up until the day before expiry?
You also want to understand the vacancy rate in the area, because that tells you how easily your tenant could leave for something comparable or better. Is there a ratchet clause, so rent can’t go down, or a cap and collar limiting movement either way? And I’d encourage you to hold all of this loosely: what you can legally do as a landlord is one thing, but I always try to find a win-win with the tenant, because you don’t want to start another five years of the relationship on an adversarial foot. Your tenant is your biggest investor, their rent covers your outgoings, your bank interest, your income, and any investor distributions if you’re running a syndicate.
You also want to understand current comparable supply, not just the vacancy rate. If you’ve got a 500 square metre office, are there other similar spaces available right now? Is the tenant suboptimal, someone you’d be glad to see replaced, or a AAA-rated tenant you’d struggle to better in the next 20 years? That shapes whether you actually want them to exercise their option at all.
Let’s map the timing. Five-year lease, year one through year five, expiring 30 June 2030. The option notice window opens 6 months prior, December 2029, and closes 3 months prior, March 2030. If the tenant exercises inside that window, they have an irrevocable right to extend. If they miss it, and the date that matters most is the one closest to expiry, they lose that right entirely. I always try to negotiate that window to open 9 to 6 months out rather than 6 to 3, because the earlier I know a tenant’s intention, the more time I have for plan B: marketing the property, organising photography, upgrading it, lining up a leasing agent, having finance conversations, or simply trying to keep the tenant if they want to stay. Too early, though, and you risk locking in a rent before the market has told you where it’s actually heading.
Now assume market rent is above passing rent, and a tenant misses their window, coming to you on the 2nd of April instead. As landlord, you might say, “I’ll grant a new option, but only with a 20% rent increase.” Having lost their option, the tenant’s choice is stark: leave, and absorb downtime, make-good costs, moving costs and the challenge of finding a comparable premises within three months, or accept the increase. Compare that to the same conversation happening in November, seven months out, where the tenant has real room to negotiate or find alternatives. That’s why understanding the landscape before the conversation is as important as the conversation itself.
Where the onus sits with the tenant to notify the landlord, I generally prefer to uncouple the option exercise from the market rent determination. The option is simply the right to stay; market rent is a separate, factual negotiation that can happen closer to expiry, sometimes right up to the day before. It gives the landlord a stronger position, though I understand tenants would rather know their rent before committing to an option, which is exactly why some leases couple the two.
If a tenant has a suboptimal fit and vacancy in the area is low, meaning you’d welcome a better tenant, you might simply stay quiet as a landlord rather than reminding them about their option. Businesses of national or even global scale miss these dates more often than you’d think, sometimes noticing only weeks before expiry, at which point you’re in a strong position to reset the terms, or let them go. If passing rent is above market rent, the dynamic reverses, and staying quiet protects the landlord from a rent reduction the tenant might otherwise be entitled to under a cap-and-collar clause.
Two things underpin all of this. First, understand the market: vacancy, comparable supply, and the tenant’s real alternatives. Second, understand your lease obligations and wording with total precision. I’ve seen a single word, the lease saying a landlord “may” determine market rent rather than “must”, be worth roughly $2 million in outcome on one property, because “may” meant I simply chose not to redetermine the rent, and the existing rent just continued through the option period. Talk to your lawyer, run the scenarios, ask “what happens if the tenant does this, or that.” Understanding the environment and the lease together is what lets you approach the tenant in a way that protects your asset value and your income, while still aiming for a win-win outcome.
If you liked this video, please subscribe for more, and you can find me at investorcode.com.au. I cover all of this in my online course, built to help owners maintain yield, maximise value, and enjoy this gorgeous asset class called commercial property. Thanks so much for watching, and I’ll see you in next week’s video.