Eight points to consider when entering a commercial lease

Entering into a commercial lease is a significant commitment for tenants and landlords alike. However, both heads will almost certainly clash when negotiating terms.

Entering into a commercial lease is a significant commitment for tenants and landlords alike. However, both heads will almost certainly clash when negotiating terms. Tenants will favour a lower amount of security deposit, multiple options to renew leases and fixed rent throughout the tenure of the lease. Landlords, on the other hand, favour a higher amount of security deposit, ability to increase rent on an annual basis and prefer tenants on a long-term basis to preserve continuity of the lease and stability of rental income.

It is therefore imperative for both parties to conduct their due diligence before entering into a commercial lease, to ensure favourable outcomes can be achieved. We have compiled an eight-point checklist for you to keep in mind:

  1.     Types of lease: Retail or non-retail?

There are two (2) types of commercial lease, a retail lease governed by the Retail Leases Act 2003 (Act), or a non-retail lease. The distinction on whether the Act applies is determined by section 4 of the Act, being, is the premises predominantly used for:

  • The sale or hire of goods by retail or the retail provision of services; or
  • Carrying on a specified business or a specified kind of business determined by the Minister under section 5 of the Act.

In brief, if the tenant is supplying goods or services from the premises, then it would be more probable than not that this is a retail lease. Where appropriate, tenants should negotiate entering into a retail lease to be afforded the protections under the Act.

The Act imposes obligations on both parties however it would usually be more favourable for the tenants to have a retail lease arrangement, i.e. Landlords cannot pass on certain costs to tenants in a retail lease, such as, landlord’s legal costs for preparation of the lease, mortgagee’s consent, land tax or costs relating to essential safety measures. Further, landlords are obliged to provide tenants with a Disclosure Statement which outlines important information about the lease and the occupancy costs (including outgoings), however not so if the lease is non-retail.

  1.     Rent increase and review method

Tenants may not be aware that rent is increased on an annual basis, usually determined by fixed rate or percentage increase or by Consumer Price Index increase. If the lease contains any further terms, then a market review will be conducted to determine the new rental amount for the renewed lease period.

Important: It is a common misconception that tenants can walk away from the lease if they have exercised an option to renew the lease and disagree on the new rental amount. This is simply not the case.

Should the tenant disagree with the rental amount, the lease would contain provisions that an independent valuer be mutually appointed by both parties, to determine the revised rent. Please note that landlords are entitled to receive rent for the remaining period of the lease if the lease is incorrectly “surrendered” by the tenants.

  1.     Mortgagee’s consent

Is the property mortgaged? If it is, tenants should request that landlords provide them with mortgagee’s consent to the lease, a copy should be annexed to the lease documentation. If this is a retail lease, then such costs must be borne by the landlords and cannot be passed on to the tenants.

Important: Failure to obtain mortgagee’s consent can be disastrous. Whilst the lease is binding between you and the landlord, it is not binding with the mortgagee until the mortgagee’s consent is obtained. If the landlord defaults on their mortgage, their mortgagee can take possession of the premises and terminate the lease immediately.

  1.     Fit-out

Are you a tenant thinking of renovating or fitting-out the premises? Think again, and ensure that appropriate clauses are included in the lease to ensure the fit-out works can be completed.

Important: It is standard provision that all fit-out works and plans must be subject to the approval of the landlord as well as local councils. Tenants should check whether the intended use of the premises is permitted under the relevant zone and if a planning permit is required, to avoid receiving contravention notices from local councils to vacate the premises.

In newer developments, landlords may offer rent-free periods or incentives to assist tenants with their fit-out works.

  1.     Costs

The line is often blurred on costs incurred by tenants when entering into leases.

Besides paying rent, tenants will be responsible for paying the following costs, including but not limited to:

  •   council rates;
  •   water rates;
  •   insurance;
  •   owners corporation fees;
  •   air-conditioning maintenance costs;
  •   security deposit (and increases);
  •   land tax (if a non-retail lease is in place);
  •   landlord’s legal costs (if a non-retail lease is in place);
  •   mortgagee’s consent (if a non-retail lease is in place);
  •   repairs;
  •   refurbishments; and
  •   make good at the end of the lease.

The benefit of having a retail lease is that landlords are obliged to disclose and provide a breakdown of outgoings to the tenants. Please note the above is not an exhaustive list and both tenants and landlords can reach a compromise on costs to be borne by the tenants.

Important: Further, tenants are often unaware that landlords are entitled to increase the amount of security deposit held ‘from time to time’ as stated in the lease. The lease may contain provisions that allow landlords to increase the security deposit amount on an annual basis when the rent is increased, for their protection.

  1.     Demolition, redevelopment or relocation

Tenants are often shocked when advised that the lease contains a demolition, redevelopment or relocation provision.

A demolition, redevelopment or relocation clause allows the landlord to terminate the lease, by providing sufficient written notice to the tenant, usually to carry out major works at the property for redevelopment. Whilst these provisions are valid, tenants should be compensated for such inconvenience. In some instances, tenants may consider that it is expensive for them to relocate and should resist these clauses from being included in the lease, as it may cause irreversible damage to the tenants’ business.

  1.     PPSR and security interests

The registration commencement date for the Personal Property Securities Act (PPSA) was effected on 30 January 2012. It introduced a new national system known as the Personal Property Securities Register (PPSR) where details of security interests can be registered and searched, usually for the performance of an agreement.

Similarly, there are instances where the landlord can register a security interest on the PPSR against the tenant’s entity to protect their interest, if the tenant entity becomes insolvent, wound up or placed into administration.

An example is when tenants pay their security deposit by way of cash instead of bank guarantee. In this instance, if the landlord failed to register their security deposit, and if the tenant becomes insolvent, the landlord will find themselves in a situation where the security deposit is paid to other secured creditors before the landlord.

Failure to properly register the landlord’s interest on the PPSR may result in a landlord being an unsecured creditor.

  1.     Condition report

Similar to a residential lease, tenants and landlords should prepare a joint condition report upon commencement of the lease, which contains a list of the chattels and installations of both parties, as well as photographs as annexures. The condition report will help in avoiding future disputes about damage, repair and replacement of the premises as well as the tenant’s ‘make good’ obligations under the lease.

Not conducting thorough due diligence of your lease prior to signing can cause significant and costly ramifications. Seek an experienced solicitor to discuss the above checklist to ensure that your rights are being protected, as a landlord, or a tenant. We welcome you to contact us for a full and frank discussion.

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