What is Lease Extension?

Explanation

A lease is a contractual agreement entered between lessorLessorA lessor is an individual or entity that leases out an asset such as land, house or machinery to another person or organization for a certain period.read more and lesseeLesseeA Lessee, also called a Tenant, is an individual (or entity) who rents the land or property (generally immovable) from a lessor (property owner) under a legal lease agreement. read more. 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.

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Eligibility

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:

  • The lease required to be extended must be a residential lease. In other words, commercial property is outside the purview of the extension.The original lease must be for at least 21 years; SO, if you are 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.You must have owned the leasedLeasedLeasing is an arrangement in which the asset’s right is transferred to another person without transferring the ownership. In simple terms, it means giving the asset on hire or rent. The person who gives the asset is “Lessor,” the person who takes the asset on rent is “Lessee.”read more property for at least two years; it is important to understand that you may have not necessarily lived for all that time, but you definitely must be the owner of the lease;

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

  • In case the property is owned by Crown or National Trust;In case property falls within boundaries of the cathedral;Your ownership in the lease is less than 100%;

When is it expected to extend a Lease?

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 you plan to use the property or the asset for longer-term;An extended lease term can help in generating higher sale value;When you need 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.

How is it possible to extend a Lease?

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.

Cost of Lease Extension

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.

Process of Lease Extension

You 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, you can talk to your lessor, make a reasonably good offer, and, once negotiated, go ahead with an extension.

Examples

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.

  • Appoint a legal expert/solicitor to assist you in all legal processes. Get the property valued by an official valuer. First and foremost, you should contact your lessor and inform them about your requirement to extend the lease. Make a reasonable offer to the lessor. You may also serve a notice to him stating the number of years you seek for the extension. You may also serve a notice to him stating the number of years you seek an extension. Make a security deposit with the lessor. Negotiate the amount and get the extension in place.

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 paymentA Lease PaymentLease payments are the payments where the lessee under the lease agreement has to pay monthly fixed rental for using the asset to the lessor. The ownership of such an asset is generally taken back by the owner after the lease term expiration.read more.

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.

Conclusion

To summarize, a lease extension means 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.

This article has been a guide to What is Lease Extension and its definition. Here we discuss cost, process, and examples of lease extension along with its eligibility. You can learn more from the following articles –

  • Leveraged LeaseGround LeaseModified Gross LeaseGross Lease