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. Last Updated: 07/27/2016

Protecting Landlord, Lessee With Lease Renewal Options

Renewal options are a common feature of leases of commercial buildings in the Moscow market. Usually, the option will entitle a lessee to require a new lease upon expiry of the original term. Sometimes, the new lease will be on the same commercial and contractual terms as the original. Often, however, the option will provide for some form of rental revision.

A number of developers have granted lessees rights to renew at a higher rent at the end of the original term. Increases of 5 to 10 percent on the renewal of a five-year lease are not uncommon.

Although many brokers take the view that Moscow rents are unlikely to rise in the medium term, options to renew at fixed rental increases are not unreasonable, if one considers the rental increase as the lessor's only hedge against inflation over what might be a 10-year period. In return, the lessee obtains security of occupancy and price certainty. It is not required to accept or share any risk: If the market falls, the lessee is free to negotiate new terms rather than exercise the option.

Recently, though, there has been a move toward including renewal options at "a fair market rent." In the past, this was usually at the request of lessees, but developers now seem increasingly prepared to agree to a market-based rent review, and some now include market-rent-based renewal options in their standard lease.

Market-based rent reviews may have advantages for both parties. In many Western countries their use has led to the development of laws defining the meaning of "market rent." In such countries, the "rent review" procedure is well understood by brokers, valuers, lawyers and courts. In addition, industry journals, by detailing recent transactions, provide useful evidence of current rentals on comparable premises.

Because market-rent-based review is a relatively new concept in Russia, it is extremely important for the option precisely to stipulate the basis on which "market rent" is to be assessed. An option which provides for valuation simply on the basis of appearance may result in an unfair assessment. For example, unless an assessor is specifically directed to disregard the rental effect of lessee improvements, a lessee that leased shell-and-core premises and then spent $400 per square meter fitting out the space could be required to pay a higher rent as a result of improvements it had itself made and paid for.

Similarly, unless an assessor is directed to assume that a lessee has complied with its lease obligations, a lessee which, in breach of its repair obligation, had allowed premises to fall into disrepair, could profit from that breach if the assessor decided to reduce the rent payable on account of the poor repair.

Additional relevant matters which should be "assumed" or "disregarded" by an assessor if a fair balance is to be struck between the respective interests of lessor and lessee include goodwill, rental prepayments, performance of obligations by the lessor and the form of lease contract.

Finally, it is important for the option to stipulate how an assessor will be appointed and the rules within which he or she will operate. Western companies will often argue for the assessor to be appointed by an independent (and usually Western) real estate firm with experience of the Moscow market. For the time this probably represents the most cost-effective and reliable solution.

Stephen Sumpton is an associate in the real estate department of the Moscow office of Baker & McKenzie.