When leasing commercial property, landlords need to consider numerous matters. This article looks at some of the key components of rent agreements that can cause difficulty during initial negotiations.
Bonds – A bond is money paid by the tenant when the lease begins to secure performance of their obligations. The landlord keeps the bond at the end of the tenancy if they are owed money for outstanding rent or property damage.
A bond can be paid as a:
- Security deposit – cash that is held by the rental bond board or landlord personally; or
- Bank guarantee – an unconditional undertaking provided by the tenant’s bank to pay the bond when demanded by the landlord.
A bank guarantee is preferable to a cash security deposit. If the tenant goes into bankruptcy or liquidation the guarantee can still accessed by the landlord. A cash security deposit may be called on by the trustee in bankruptcy or liquidator because it is considered an asset of the tenant. The landlord would become an unsecured creditor and it would be very unlikely you would recover what is owing.
Personal Guarantees – When dealing with company tenants, landlords should obtain personal guarantees from the company directors in addition to a bank guarantee. Personal guarantees allow you to seek recovery against the personal assets of the guarantor in certain circumstances.
Options to Renew – An option to renew included in a lease gives a tenant the opportunity to enter into a new lease with the landlord at the expiry of the initial term of the tenancy. Important things landlords should know about options to renew include:
- If you grant an option to renew, you are guaranteeing the tenant will have a lease for the option period, provided the tenant complies with their obligations during the term of the lease.
- The tenant has to choose if they want to accept the option. They have to elect to continue with the tenancy after the expiry of the initial term.
- The tenant must provide the landlord with written notice exercising the option. The lease will detail when this notice must be given, but it is usually anytime in the period between six months and three months before the lease expires.
- If the tenant exercises the option, a new lease must be drawn up. The new lease must be on exactly the same terms as the initial lease except for the start and end dates and the commencing rent, and any other agreed changes.
Rent reviews – A commercial lease should detail how and when the rent should be increased. Usually rent would be increased once each year on the anniversary of the lease commencement date and also at the beginning on any option lease.
There are three common methods used to calculate a rent increase:
- Consumer Price Index – This method would increase the amount of rent payable by the percentage increase in CPI. This is calculated by looking at the change in the CPI number between the quarter immediately preceding the last rent review date and the quarter immediately preceding the current review date. Whilst CPI is the most balanced method of calculating an increase, it does not necessarily take into account local market fluctuations or supply and demand.
- Fixed percentage – This is an increase in the rent by a set amount, e.g. ‘3%’. This method provides certainty as to the amount of rent but it does not allow flexibility – the market or CPI, for example, may have actually increased much more than the percentage.
- Market rent – This is arguably the most complicated method of calculating a rent increase. It considers the rent that would reasonably be expected to be received for the property and takes into account a variety of factors including the terms of the lease and what the rent would be if it the property were unoccupied and being used for the same purpose. Market rent can compensate for any changes in the local rental market but it is predominately driven by supply and demand – this may not always take into account all a landlord’s economic considerations such as interest rate rises, increases in rates and taxes or inflation.
A landlord can choose to use a combination of these methods – for example, CPI increase annually during the term of the lease and market rent on the exercise of any option. In retail leases, the landlord cannot use a rent increase which is the higher of two different methods.
These are some of the matters a landlord should consider when leasing commercial property. As a firm highly experienced in commercial property matters, Marriott Oliver are able to guide you through all the issues you should consider when negotiating a lease and provide advice tailored to your personal circumstances. If you would like advice or assistance with your next leasing matter, please do not hesitate to contact us.
Lauren Howes – Marriott Oliver Solicitors Pty Ltd – 2016