Commercial leases – 8 key considerations for tenants

by RP Emery and Associates

Signing a commercial lease can have serious legal and financial implications for your business. Here are eight key elements you should consider before signing yours.

  1. Permitted use

Not all commercial property leases contain a permitted use clause. However, if there is one in your contract, you should negotiate it as broadly as possible. This not only enables you to grow and diversify your business, it also ensures a future buyer of the business or assignee of the lease is also able to use the premises for multiple purposes. Ask yourself:

  • Is the permitted use fit for my business – both now and in the future?
  • Are there any exclusions?
  • If I sell my business or assign the lease during the lease period, will the use unduly restrict the buyer or assignee’s activities? 
  1. Rent

Besides ensuring you can afford the rent over the entire lease period, you should also consider:

  • How often the rent is paid – weekly, monthly, in advance? Does the payment schedule accord with your expected cashflow?
  • What’s the current vacancy rate in the area? Is the landlord experiencing a high or low vacancy rate? Can you negotiate a rent free period to allow for fit out and preparation for trading? Will the landlord contribute to these costs?
  1. Rent reviews

When considering the entire lease cost, it’s essential you factor in rent reviews. They usually start 12 months after the start of your lease and continue annually. The amount of rent you pay after a rent review is determined using one of three methods:

Inflation or CPI adjustment

Under this kind of rent review, your rent is adjusted according to the current inflation rate or CPI. It’s usually based on movements within a particular catchment area.

Market rent review

Market rent reviews are based on a calculation of the ‘current market rent’. The calculation is carried out by a mutually appointed specialist retail valuer to make the rent determination. Your rent may be adjusted upwards or downwards as a result of this review.

Fixed amount or fixed percentage increase

A fixed amount or fixed percentage review is a fixed annual increase or decrease applied every year for the life of the lease. They can be highly advantageous to both parties as they allow each party to calculate the entire rent over the duration of the lease.

Regardless of the type of rent review you agree to:

  • Your lease must specify when and how rent reviews are to occur
  • In most states, changes to base rent can’t occur more frequently than 12 months after the first anniversary of the start of the lease
  • ‘Ratchet clauses’ preventing the rent from decreasing on a market rent review are void in every state
  1. Lease term

Your lease term should be long enough to support the goodwill of your business and recover your rental investment. But it also needs to suit your circumstances.

For well established businesses, security of location is an important factor and a longer lease may be appropriate. It may also give you more bargaining power when it comes to rent. For newer businesses lacking negotiating power, a shorter lease may be your only choice.

  1. Options to renew for a further term

An option gives you the right to renew your lease for an additional term, without imposing any obligation to do so. Helping you maintain the value of your ongoing business, they’re crucial in securing your tenure.

When considering options – flexibility is key. They’re usually exercised in writing between three and six months before the end of the lease. They also usually involve a market rent review. Before signing, ask yourself:

  • Can you renew the lease – when, and for how long?
  • How do you exercise the option and when do you need to take action?
  • Are there certain events that ‘trigger’ the option – if so, what are they and when might they occur?
  • Is a market rent review due at the beginning of the option term? (You should ask for new rent information in writing at least three months before the first option can be exercised)
  • Are breach terms attached to the option?
  • Can you break or transfer the lease or sublet part of the premises – what are the conditions and expenses? 
  1. Outgoings

Outgoings are the landlord’s expenses in operating, repairing or maintaining the premises. They may include council and water rates, security and cleaning. Although it’s common for tenants to pay these outgoings, you may be able to negotiate which ones you’re responsible for. Ensure you understand:

  • How the outgoings are calculated
  • What’s included
  • Your right of review
  • What type of disclosure and evidence of costs the landlord must supply
  1. Security deposits

By signing a commercial lease, you agree to pay rent and comply with other obligations under the lease. You do so knowing that if you default, the landlord may exercise their right to terminate the lease and take possession of the premises.

However, the landlord requires additional protection in the event there are substantial amounts of rent or other monies outstanding. For this reason, you’ll also be required to provide a security deposit. Securing your ongoing compliance throughout the term of the lease, it may take one or more of the following forms:

Bond

A bond is a cash surety the landlord holds on your behalf. Special conditions may apply (and will vary from state to state), but as long as you honour your obligations under the lease, the landlord must return your bond at the conclusion of the lease.

Bank guarantees

A bank guarantee is a promise made to the landlord by a bank to pay your debts if you’re unable to do so. Most banks require security in return for the guarantee – usually 3 to 6 months’ rent plus outgoings (but it can be as high as 12 months’ rent plus outgoings).  However, the amount is usually negotiable and is dependent on:

  • The lease term
  • The use of the premises
  • The amount of rent and outgoings
  1. Director’s guarantee

You can sign your commercial lease as an individual, or a small company. If you sign as a company, it’s common for the landlord to ask for a promise from the company directors. This protects the landlord in the event your company fails to meet its financial commitments. If such a situation does occur, the director is personally liable and is obligated to meet the company’s obligations under the lease.

 



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