What Is a Conversion Clause?
A conversion clause grants a party the legal right to fundamentally alter the structure of an existing contract without having to entirely renegotiate or refinance the agreement. In real estate, this clause is most frequently used in financing and commercial leasing.
Conversion Clauses in Mortgages
The most common use of a conversion clause is in an Adjustable-Rate Mortgage (ARM). In an ARM, the borrower's interest rate fluctuates every year based on market indexes. If interest rates are skyrocketing, the borrower's monthly payment could become unaffordable.
If the ARM contains a conversion clause, the borrower has the contractual right to lock in a fixed interest rate for the remaining life of the loan. This allows the borrower to stabilize their payments without having to pay the massive closing costs associated with a traditional refinance. The bank will usually charge a nominal conversion fee and set the fixed rate slightly higher than the current market average to offset their risk.
Conversion Clauses in Commercial Leases
In commercial real estate, conversion clauses are often used as safety mechanisms or incentives:
- Gross to Net Conversion — A startup might sign a Gross Lease (where the landlord pays all property taxes and insurance) for the first two years to keep costs predictable. The lease may include a conversion clause stating that in year three, the lease automatically converts into a Triple Net (NNN) lease, shifting the tax and insurance burdens to the tenant as the business stabilizes.
- Use Conversion — A landlord renting an old warehouse to a tenant might include a clause allowing the landlord to terminate the lease early if the city approves a rezoning permit that allows the landlord to convert the warehouse into luxury residential condos.
Related Terms
- Mortgage — The document containing the ARM conversion clause
- Refinance — The expensive process a conversion clause helps avoid
- Net Lease — A lease structure that a gross lease might convert into
Barnes Walker Commercial Financing
Barnes Walker's attorneys assist commercial borrowers and landlords in reviewing complex loan documents and lease agreements to ensure conversion clauses are drafted with clear execution windows and predictable fee structures. Request a legal inquiry for assistance.
Reviewed by the attorneys at Barnes Walker, Goethe, Shea & Robinson, PLLC