Understanding commercial leases

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It’s important when negotiating a commercial lease that you are familiar with the key terms and conditions of the lease.

When negotiating a commercial lease, it is crucial to understand the key terms and conditions included in the lease agreement.

A commercially viable lease requires a clear understanding of all clauses and conditions. Your proposed lease may also contain additional terms that affect your business operations.

Before signing any lease documents, taking possession of the property, or making any payments, it is essential to seek independent legal, financial, and business advice.

Lease duration and options to renew

It’s important to ensure the lease term is long enough for your business to recover its investment and achieve profitability. Keep in mind that once the lease expires, the landlord is not obligated to renew it, and you may need to relocate. Since much of your business’s goodwill may be tied to the premises, it’s essential to protect this by negotiating favorable lease renewal terms.

Options

Ensure the lease provides options to renew, allowing your business to continue operating at the same location after the initial term. For new businesses without a proven track record, a short lease with renewal options, such as one year followed by two, two-year options, may be suitable. For established businesses seeking stability, a longer lease with extended options may be preferable, such as a two-year term followed by three and five-year options.

Under the Commercial Tenancy (Retail Shops) Agreements Act 1985 (CT Act), tenants have the right to a minimum tenancy period of up to five years. If the lease doesn’t offer this, tenants have a statutory option to extend. To exercise this option, tenants must submit a Notice of Exercise of Option at least 30 days before the lease ends.

Remember, once the lease expires, the landlord is not obligated to renew it, so securing renewal options is important to safeguard your business’s goodwill.

Exercising your option

Your lease should outline the process and timeline for notifying the landlord if you wish to exercise your option. Typically, this notification should be done in writing between three to six months before the lease expires.

Under the CT Act, the landlord is required to provide you with at least 6 to 12 months’ notice before you must take action to renew your lease. Ensure you follow the correct procedure and timelines to secure your renewal option.

Tip

Failing to exercise your option within the specified timeframe or as outlined in the lease agreement may result in your lease not being renewed by the landlord. Ensure you adhere to the process to avoid complications.

Rent and rent reviews

Negotiating rent and its review frequency with the landlord is a key part of a commercial lease. While rent reviews typically occur annually, you can discuss less frequent reviews if preferred.

Under the CT Act, leases must only use one method to calculate rent reviews. Common methods include:

Consumer Price Index (CPI) adjustments
Fixed percentage increases
Fixed monetary amounts
Market rent assessments

Ensure you evaluate whether proposed rent increases are manageable throughout the lease term and any renewal periods to maintain financial stability.

Market rent

When a market rent review applies during a lease renewal, it is essential to confirm the proposed market rent with the landlord before proceeding. This ensures that the rent aligns with current market conditions and remains commercially viable for your business.

Percentage rent

It is advisable to avoid leases with rent reviews tied to a percentage of turnover. Such agreements typically require paying a base rent plus additional rent based on your turnover after reaching a specific threshold.

This clause necessitates sharing turnover details with the landlord, which might impact future lease negotiations or the sale of your business. Proceed cautiously when considering such arrangements.

Permitted use

A lease usually includes a clause that outlines the permitted use of the premises.

You should ensure that the permitted use allows you to do all the activities required to operate your business. This includes all the types of goods you want to sell and services you want to provide.

Don’t just think about your current activities, consider what you may want to offer to expand your business in the future. For example, if you are only permitted to sell pizza this could cause problems if you want to add hamburgers or coffee to your menu.

The permitted use may also limit your opportunities to assign the lease to another person if you want to sell the business or leave the premises before the lease expires. You should try to negotiate a permitted use that is sufficiently broad enough to protect your future business interests.

Tenancy mix and competition

When choosing premises, evaluate the mix of tenants in the shopping center or precinct. Businesses in the area should ideally complement, not compete with, your offerings.

Consider negotiating an “exclusivity of trade” clause in your lease. This clause prevents direct competition and ensures you are the sole provider of a specific product or service within the landlord’s property portfolio.

Anchor tenants

Anchor tenants like supermarkets or department stores can attract significant foot traffic, benefiting nearby businesses. If your business depends on their presence, negotiate lease terms that offer protection. For instance, include a clause allowing you to terminate the lease or seek a rent reduction if the anchor tenant leaves or if there’s a notable decline in tenant occupancy at the property.

Cost

Leasing commercial premises involves more than just paying rent. Additional costs can be significant and may include ongoing expenses that increase over time. These should be carefully evaluated and factored into your negotiations to ensure they fit within your budget and business plan.

Operating expenses or outgoings

Operating expenses refer to costs the landlord incurs for operating, maintaining, or repairing the premises. These can include land tax, council rates, water rates, security, cleaning of shared spaces, and general maintenance.

Before signing a lease, understand the operating expenses you may need to cover, as they can add significantly to your total costs. Attempt to negotiate so these expenses are not your responsibility. If unavoidable, aim to limit them to costs that directly benefit your premises and set a cap on potential increases during the lease term.

Structural repairs and capital items should be argued as landlord responsibilities since these offer long-term benefits to the property owner. Leases under the Commercial Tenancy (Retail Shops) Agreements Act must itemize all operating expenses you are required to pay. Additionally, ensure the lease allows access to invoices and receipts for transparency regarding actual expenses.

Insurance

Your lease may require you to obtain insurance for building damage and public liability. Carefully review any indemnity clauses in the lease, as these could obligate you to compensate the landlord for losses, unlawful acts, or damages, potentially breaching your insurance policy.

Consult your insurer about any insurance-related clauses before agreeing to them. This ensures compliance with your policy and protects your business from unexpected liabilities.

Legal costs

The legal costs for preparing and negotiating the lease can typically be negotiated between you and the landlord. Aim to agree that each party covers their own legal costs, or at least set a cap on your contribution to the landlord’s expenses.

Avoid clauses requiring you to pay the landlord’s legal costs in the event of a dispute. For leases governed by the CT Act, landlords cannot require you to pay for:

Preparing, negotiating, executing, renewing, or extending a lease.
Obtaining lender consent if the property is mortgaged.
Complying with the CT Act.

However, landlords can charge you for legal costs and expenses related to assigning or sub-leasing the premises.

Security bond

At the start of a lease, you may need to provide a security bond, with the amount subject to negotiation. The lease agreement should clearly outline the conditions for using, withholding, and repaying the bond.

It is advisable to ensure the bond is deposited into a separate interest-bearing account that includes either your name or details of the leased premises.

Fit-out and condition of premises

Fit-out refers to preparing leased premises for occupation as per the tenant’s requirements and landlord’s agreement. This process may involve installing elements like shop fronts, flooring, fixtures, and fittings.

The lease should clearly specify the fit-out requirements and who bears the associated costs. It’s advisable to negotiate ownership of fit-out items so that you can retain them at the lease’s end. Fit-out costs can be significant, so allocate an adequate budget when planning to lease premises.

Under the CT Act, tenants are not obligated to contribute to the landlord’s finishes, fixtures, or equipment unless these costs are disclosed in the Disclosure Statement provided at least seven days before signing the lease.
Account for potential delays in fit-out completion, especially during peak seasons like Christmas, when trade services may face shortages.

Refurbishment

You may be required to refurbish the leased premises during the lease term, particularly in shopping centres where maintaining an updated image is essential. It’s advisable to negotiate refurbishment requirements to limit them to every five or six years.

For leases covered by the CT Act, any clause that mandates refurbishment or refitting must include sufficient detail about the nature, extent, and timing of the work. Without this information, such a clause will not be legally valid.

Marketing and promotional funds

Your lease may require you to contribute to marketing or promotional funds, typically used for advertising or other promotional activities within a shopping center.

Before entering into the lease, it’s important to clearly understand your contribution to these funds. Negotiate terms that limit your financial commitment and ensure you have a say in how the funds are allocated.

Repair and maintenance

Your lease should clearly outline the responsibilities for repairs and maintenance. Aim to negotiate that the landlord takes responsibility for structural elements and major capital items, such as the building’s roof, walls, air-conditioning systems, exterior fittings like gutters and downpipes, and plant or equipment owned by the landlord.

As the tenant, you may be required to handle repairs and maintenance for internal surfaces, including floor coverings, doors, windows, and any landlord-provided equipment or fixtures.

For items like air-conditioners and fire sprinklers, negotiate terms where the landlord is responsible for replacement once their lifespan ends, while you handle routine maintenance.

Tip

Before signing a lease, arrange for an independent inspection of the premises. Both you and the landlord should agree to a detailed condition report, including photographs. This report can serve as essential evidence in resolving disputes at the end of the lease, particularly concerning the condition of the premises or equipment and whether any issues result from fair wear and tear.

Compensation for disruption caused by landlord’s works

If your landlord undertakes work that disrupts your business, such as maintenance or redevelopment activities, you may be eligible for compensation. Refer to our guide on claiming compensation for disruptions caused by the landlord’s works for detailed information.

Assignment and sub-leasing

If you plan to assign your lease (transfer it to another person) due to selling your business or ceasing operations, you will need your landlord’s consent. Ensure your lease specifies that consent cannot be unreasonably withheld.

Reasonable grounds for denial might include the new tenant having poor credit, being unlikely to run the business successfully, or planning to use the premises for purposes not allowed under the lease.

When assigning a lease, be aware that you may remain liable if the new tenant defaults. Under retail leases governed by the CT Act, clauses making you liable for the new tenant’s defaults are not legally valid. For leases not covered by the Act, negotiate a release from liability upon assignment.

Sub-leasing part or all of your premises means you remain liable for the lease, including rent payments if the sub-tenant defaults. It’s essential to perform a credit check and ensure the sub-tenant can meet the lease terms.

If sub-leasing is governed by the CT Act, you must fulfill responsibilities similar to a landlord, such as providing the sub-tenant with a Disclosure Statement and Tenant Guide.

Additionally, when assigning or subletting, you may need to cover the landlord’s reasonable legal and related costs.

Defaults and breaches

Failing to pay rent on time puts you in default of your lease, allowing the landlord to take action to recover the outstanding amount. Many leases grant landlords the right to enter the premises and lock you out without prior notice.

The landlord may also claim compensation for lost rent up to the lease’s end, along with costs related to reinstating and re-letting the premises. If the premises are re-let at a lower rate, the landlord may recover the shortfall, additional losses, and legal costs incurred due to your default.

When negotiating your lease, ensure default clauses include a requirement for the landlord to provide written notice of any default. You should also negotiate a reasonable timeframe (at least 14 days) to address and rectify the issue before any action is taken.

Breaching the lease, such as neglecting repair or maintenance obligations, may also lead to consequences. Again, it is crucial to include terms in the lease that require written notice and sufficient time to correct any breach before further action is initiated.

Redevelopment and relocation

A redevelopment clause in your lease may allow the landlord to terminate it early for major renovations or redevelopment. This could result in losing your premises or being relocated, which can significantly disrupt your business operations.

Where possible, negotiate to remove redevelopment and relocation clauses from the lease. If this isn’t feasible, ensure the lease includes compensation for any loss of trade or goodwill caused by relocating. It should also cover relocation expenses and other associated costs.

You might also negotiate for a rent reduction if your business is negatively impacted. The redevelopment clause should provide enough compensation to place you in a similar position as if the redevelopment hadn’t occurred.

For leases regulated by the CT Act, there are specific requirements addressing redevelopment, relocation, and early lease termination to safeguard tenants’ interests.

Tip

Carefully evaluate the risks associated with redevelopment and relocation clauses in the lease. If adequate compensation cannot be negotiated, consider whether the potential impact on your business outweighs the benefits of entering into the lease. Ensure you make an informed decision that aligns with your long-term business interests.

Termination

Review the lease carefully to identify any clauses that allow the landlord to terminate the lease early. If such clauses exist, negotiate to have them removed to ensure greater security and stability for your business operations.

Useful resources

Leasing Business Premises: A Commercial and Practical Guide

This guide outlines key considerations and helps you avoid common pitfalls when leasing business premises.

How to Negotiate Your Way to a Better Lease

This guide covers important aspects of retail lease negotiations and highlights issues that can arise during the lease term.

Common Questions About the Commercial Tenancy Act: For Leases Entered Into on or After 1 January 2013

This resource provides guidance for landlords and tenants entering into leases under the Commercial Tenancy Act.

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