LEASING PROFESSIONAL

LEASE AGREEMENT REFERENCE GUIDE

LARG 530
STRATEGIES FOR THE FAIR MARKET VALUE OPTION TO PURCHASE

Product Number: LARG530 Serial Number: 90212-88555 www.leasingprofessional.com

STRATEGIES FOR THE FAIR MARKET VALUE OPTION TO PURCHASE
The Pro-Tenant Option To Purchase The Premises For Fair Market Value And Right Of First Refusal
It is fairly clear that any option to purchase the premises will operate in the tenant's favor. This is particularly true of fixed price options, since the tenant stands to gain a windfall if the property value appreciates over the lease term. That is precisely why most large tenants with good leverage try to negotiate an option to purchase their premises in all their leases as a matter of policy. The landlord might be inclined to agree to the option if the lease is otherwise sweet enough, or forced to if the tenant will not do the deal without an option. Many fixed price options are calculated based upon the landlord's development cost for the building plus a healthy profit over the landlord's development and holding period. However, calculating fixed option prices has always been, and will always be, a risky practice for the landlord. It is a gamble on the market that only the tenant can win.

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Fixed Price Problems
Unlike the option clause that follows (with an option price based upon the fair market value of the property), most first generation option clauses contained a fixed price for the property. In fixed price option clauses, this means that the landlord and tenant agreed upon the property's value as of the execution of the lease. During the term of the lease, only three things could happen to the property's value--it could increase, stay the same, or decline.

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The tenant would exercise the option if the property's value increased during the term of the lease. This would give the tenant a gain equal to the value of the property as of the exercise date less the fixed price it was obligated to pay under the option clause. If the property value declined during the term of the lease, then the tenant would almost certainly let the option lapse. If the property's value stayed the same as when the lease was executed, and roughly equaled the fixed purchase price under the option, the tenant would probably not exercise without a monetary gain, unless it liked the location of the building or other factors associated with the property motivated its exercise.

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When the property value increased over the term of the lease (i.e., over and above the fixed purchase price contained in the option), an exercise of the option would do little for the landlord's good humor. In the landlord's view, the tenant was enriching itself with the landlord's real estate. Many landlords who found themselves in this situation resisted the tenant's exercise of the option in court. They would claim the option was unenforceable for a variety of reasons, that the option violated the rule against perpetuities, or anything else that they or their counsel hoped would be persuasive to a judge. The are in ms wordof This document excerpt appears in Adobe PDF format. Downloaded documents combination
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an increase in property value and a fixed price option has generated much litigation and case law concerning options to purchase.

The Fair Market Value Approach
The option that follows sets the option purchase price as the fair market value of the property agreed upon between the landlord and the tenant as of the time of exercise. If the landlord and tenant cannot agree upon the fair market value of the property, the clause provides for an appraisal process to determine its fair market value. This approach avoids the disputes that commonly arise when a fixed price option is used and the property value has increased over the term of the lease. It also makes it easier for the landlord to agree to the option as part of the lease package. Assuming the landlord and tenant can agree upon the purchase price after exercise, or if they cannot, that the appraisal process works fairly, both the landlord and the tenant should be happy with the outcome following the tenant's purchase of the property.

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Lease Clause Critique: Option To Purchase For Fair Market Value And Right Of First Refusal—Clauses And FULL SIZE EXCERPT Comments
This Lease Clause Critique looks at a pro-tenant clause giving the tenant the option to purchase its premises for fair market value. Beginning with Section 28.8, the clause also contains a right of first refusal in favor of the tenant. This provision gives the tenant the right to match the terms and conditions of a third party offer if the landlord receives one during the term of the lease. The clause that follows is aggressively pro-tenant in tone, although the market is used to determine the option price.

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Sample Clause

Section 28.1. Landlord hereby grants to Tenant the option (the "Purchase Option") to purchase the Premises by written notice from Tenant to Landlord (the "Purchase Option Notice") given not more than three hundred sixty (360) days, nor less than one hundred eighty (180) days, prior to the Expiration Date of the Initial Term or each applicable Renewal Term, as the case may be. The purchase price for the Premises shall be equal to the "Fair Market Value" of the Premises, which shall be determined as hereinafter set forth.
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their determinations of value, and the difference between the values is less than ten percent of the lesser valuation. If that proves to be the case, then the two values are added together and fifty percent (50%) of that sum is deemed to be the fair market value for the property. (d) If the difference between the amounts so determined exceeds ten percent (10%) of the lesser of such amounts, then (i) such two Appraisers shall have twenty (20) days to appoint a third Appraiser; (ii) if such Appraisers fail to do so, then either Landlord or Tenant may request the American Arbitration Association or any successor organization thereto to appoint an Appraiser within twenty (20) days of such request and both parties shall be bound by any appointment so made within such twenty (20) day period; and (iii) if no such third Appraiser shall have been appointed within such 20 (twenty) days or within ninety (90) days of the Price Determination Date, whichever is earlier, either Landlord or Tenant may apply to any court having jurisdiction to make such appointment.

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Comment: Section 28.3 (d) covers the situation where the difference between the two valuations is greater than ten percent of the lesser valuation. In that case, the two initial appraisers have twenty days to appoint a third appraiser. If they fail to do so, then either landlord or tenant can request the American Arbitration Association to appoint a third appraiser. Finally, if a third appraiser is not appointed by the two initial appraisers, or by the American Arbitration Association, then either landlord or tenant can request any court with jurisdiction to make the appointment. (e) Such third Appraiser, however selected, shall be jointly instructed by Landlord and Tenant to determine the Fair Market Value for the Premises in accordance with Section 28.2 of this Article within thirty (30) days after such Appraiser's appointment. Of the three appraisals, the appraisal which differs most in terms of dollar amount from the other two appraisals shall be excluded, and fifty percent (50%) of the sum of the remaining two appraisals shall be final and binding upon Landlord and Tenant as the Fair Market Value for the Premises. In the event the highest and lowest appraisals differ equally from the middle appraisal, then the middle appraisal shall be final and binding upon Landlord and Tenant as the Fair Market Value.

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Comment: Section 28.3 (e) provides that the third appraiser is to be jointly instructed by the landlord and the tenant to determine fair market value for the premises within thirty days after the appraiser's appointment. After the third appraisal is complete, this clause requires that the appraisal that differs the most from the other two in dollar value will be disregarded, and that the average of the other two appraisals will constitute fair market value. The final sentence of Section 28.3 (e) is needed to ensure that a determination of fair market value is reached in the event three evenly distributed determinations of value are reached (e.g., if the first appraiser establishes fair market value at $20 million, the second appraiser at $23 million, and the third appraiser sets
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agreed to by Landlord and Tenant in writing. Comment: Section 28.5 (b) sets the time for the closing at 10:00 a.m., although if the landlord and the tenant are actually expecting recordation of the deed and other closing documents at that time, the availability of a 10:00 a.m. recording will obviously depend upon local custom and practice of the county recorder in which the property is located. (c) The Premises shall be conveyed subject only to the Permitted Exceptions and such other matters created by Tenant or arising out of Tenant's use and occupancy of the Premises, but free and clear of the lien of any mortgage, deed of trust, security interest and encumbrance created by or resulting from acts of the Landlord, any successor of Landlord, any party claiming through Landlord, or any other person, without the express written consent of Tenant. For purposes hereof, the execution of any attornment agreement with any Fee Mortgagee shall not be deemed consent to such mortgage or security interest.

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Comment: Section 28.5 (c) covers the condition of title to be conveyed at closing. That section indicates that the premises will be conveyed subject only to permitted exceptions and other matters created by the tenant or arising out of the tenant's use and occupancy of the premises. Title is to be clear of any financing liens and free of any security interest or encumbrance created by the landlord or any successor or party claiming through the landlord, absent the tenant's express written consent. Section 28.5 (c) also provides that the tenant may execute an attornment agreement with the landlord's lender without running the risk that the landlord will claim that the tenant thereby consented to such financing as a permitted exception in the event the option is exercised.

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(d) Any transfer tax, documentary deed stamps, and any other tax or governmental charges customarily paid by a seller of real property in the state in which the Premises are located, any recording charges incurred in connection with the recording of the deed to the Premises, and any title insurance premiums necessary to insure good fee title in Tenant, shall be paid in full by Landlord in cash or certified check at the closing to the appropriate governmental authorities or agencies. Tenant shall pay all other closing costs and charges incident to the conveyance of the Premises. Each party shall pay its own legal fees and administrative costs incurred in connection with any such conveyance of the Premises to Tenant.

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Comment: Section 28.5 (d) allocates closing costs between the landlord and the tenant. It provides that any transfer taxes or other governmental charges normally paid by a seller of real property, plus any recording charges and title insurance premiums will be paid by the landlord at the closing. The section obligates the tenant to pay all other closing costs. Both the landlord and the tenant agree to pay their own legal and administrative fees incurred in connection with the closing.
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