Twelve Tips for Those Negotiating a Commercial Lease

Twelve tips for those negotiating a commercial lease

Entering into a commercial lease often involves entering into a long-term commitment. Like any long-term commitment, it’s imperative to make sure both the premises and the lease terms are suitable to your needs and circumstances. By following 12 tips below, you will be putting yourself into a more substantial long-term position when negotiating a commercial lease.*

1. Rent

Commercial leases are usually negotiated on a per-square-meter basis. The lease’s annual cost is generally determined by multiplying the premises’ square meter by the asking price per square meter (psm).

Working example

A 50m² office space at $350psm equates to $17,500 per annum and $1,458.33 per month.

You should always keep in mind that GST will be applicable on top of rent.

Some landlords also offer incentives in the form of free rent or a contribution to fit out. Landlords will often have certain margins they work within in regards to incentives. They will consider factors such as the lease term and the rent increases throughout the term when considering incentive structures.

2. Security deposits and bank guarantees

The landlord will usually require a bank guarantee or security deposit to be provided when you enter into a commercial lease. The landlord holds these deposits as ‘security’ from the tenant. The landlord will have the ability to ‘draw down’ or ‘call up’ these forms of security in the event of default by a tenant under the lease.

A security deposit is usually a cash bond, and in commercial matters, this bond may be held by the landlord or in an agent’s trust account.

A bank guarantee is a form of undertaking from a bank or credit union to guarantee payment of a provisional sum to a landlord. The lease will outline the circumstances in which the landlord can ‘call up’ or ‘draw down’ the bank guarantee.

You should factor this cost in when looking at your budget.

3. Lease term

You always need to consider the lease term when negotiating a commercial lease and make sure the lease’s length suits your particular circumstances and needs.

Some tenants are looking for a long-term lease to allow them time to build up their business with tenure security. A long-term lease will be a consideration for tenants who wish to have a business that is a saleable asset.

On the other hand, if you enter into a long-term lease and your business grows faster than expected, you may find yourself in a position where you outgrow a premise, and you still have a couple of years to run in your lease term.

Landlords usually like long-term leases from a security point of view.

As a general rule, the longer the lease, the higher the incentive (if available). However, also remember the longer the lease, the more rent reviews.

4. Rent review

Commercial leases will contain rent reviews. There are not many landlords who will want a fixed rent over a long-term basis.

A rent review will be in one of the following forms (or sometimes a combination of them depending on the legislation relevant to your state):

  • Consumer Price Index increase;
  • Fixed percentage increase (for example, 3.5% each year); or
  • Market review.

You should factor these increases into your budget.

Working example

If you enter into a five-year lease with fixed increases of 4% per annum you will be looking at a rent increase of 20% over the lease term.

5. Fit out

You need to consider whether the commercial space you are looking at requires a fit out.

If it does, you should get an idea of fit-out costs from a fit-out contractor or builder. The cost of fit out should always be considered when you are looking at your budget.

As indicated in tip one, sometimes the landlord will be prepared to contribute towards your fit out costs. You should often note these contributions are only provided after the works have been completed, paid for and final certificates obtained.

You should also check when negotiating the lease whether you will attend to your fit out prior to lease commencement and handover or following lease commencement and handover. Different landlords have different approaches to fit-out periods.

6. Permitted use of the premises

The lease will need to contain a permitted use. What will you be using the premises for?

It is in a tenant’s interest to negotiate a broad permitted use. This will allow for future diversification of the business if need be or may allow a sub-lease arrangement (landlord consent will likely be needed to enter into a sub-lease).

Once a lease is signed and binding, any changes to the lease may not be possible unless the lease is varied or amended. This can be timely and costly.

7. Outgoings

If the landlord is passing on the outgoings (or operating costs) to you, and is charging separately for these services, negotiate a fixed-fee or cap on the amount. Also, make sure the landlord is transparent and discloses these expenses to you before you enter into the lease.

8. Assignment and sub-leases

You should make sure your lease allows you the ability to assign the lease or to sub-lease part of the premises.

For example, if you were to sell your business you would need the ability to assign the lease to the incoming party. If business structures change (for example, shareholdings or reorganisation) the lease may also need to be assigned.

Assignments and subleases are subject to the landlord’s consent. There are often conditions attached to this consent process.

9. Alterations and improvements

Most commercial leases specify that tenants require the landlord’s consent if they want to make changes or add improvements to the tenancy.

You should include a clause in your lease that allows you to make alterations and improvements to the property. These clauses are usually drafted on the basis the landlord must give its consent which will not be unreasonably withheld.

10. Make good and refurbishment

You should always be aware of the ‘make good’ clause or ‘yield up’ clause in your lease.

Many commercial leases state that the tenancy must be brought back to a vacant shell at the end of the lease. What if it was not a vacant shell when you entered into the lease?

Other leases state the tenancy must be returned in the condition it was at the start of the lease. What if you took over the lease with a partial old fit out that you ripped out during your fit-out process?

Commercial leases often also have redecoration clauses. This means that when asked, you must redecorate the tenancy at a specific date or under certain circumstances.

11. First right of refusal

Tenants have the ability to negotiate a first right of refusal clause into a commercial lease.

These clauses are drafted on a case-by-case basis.

Working example

A tenant is looking at taking a 350m² office space in a building but considers they may need more space if their business expands in the future. There is a further 100m² vacancy next to their current tenancy they consider may be good for them when the time is right. The tenant may negotiate a first right of refusal clause into their lease which would obligate the landlord to present this space to them in the event the landlord has another offer from a third party.

12. Costs

You should be clear on who pays what in relation to the lease process.

Types of costs involved in commercial lease preparations are legal costs, mortgagee consent fees, and registration costs. There are circumstances where a tenant can be asked to pay for the landlord’s lease preparation costs.  You may wish to negotiate a term that each party bears its own costs in relation to lease preparation.

*Please note the above relates to commercial leases only.  Different rules govern retail shop leases.

The dos and don’ts of commercial property investing

After working in the property investment arena as an active investor and advisor for over a decade, I’ve seen almost every strategy out there. From entry-level ‘buy and hold’ residential investments, to blue-chip ‘buy and hold’ assets, right through to the confusing world of commercial property investment.

It’s the latter that really is not for the faint-hearted. Commercial property investment can be one of the most lucrative investments in real estate, and I’ve seen clients realise extraordinary capital gains and huge cashflow wins. But I’ve also seen the opposite — two-year vacancies, significant drops in market value and people losing it all.

Put simply, commercial property investment is higher risk than residential property investment, and for those not well versed with its nuances or trends, it’s essential to avoid costly mistakes.

Here are some dos and don’ts for commercial property investors.

Do have a plan

Before investing your hard-earned cash or equity in a commercial property, you must have a plan. Having a proper investment plan better equips you to recognise the right property when it comes along.

Many commercial investors make the mistake of buying a commercial property because it seems like a good deal and then attempts to fit into their plan.

But seasoned investors not only have a plan, they understand how a commercial investment can fit into an existing portfolio (typically with a number of residential investments), with a big focus on the long-term strategy, risk mitigation, capital growth, and above all, cashflow.

Don’t believe the hype that you can make money quickly.

I’ve seen plenty of first-time investors take the leap into the commercial real-estate space, only to have the tenant go into receivership or liquidation within months of the contract settling, and then having to hold the asset vacant for months and months on end.

Remember, commercial real estate is only as good as the lease and tenant in place.

Don’t think you can invest in commercial property single-handedly.

Successful commercial investors rely on a team of professionals to assist them. From setting a clear strategy, commencing detailed research and choosing the right property at the correct price with the right conditions, right through to settlement and property management — your team needs to complement your shortfalls in knowledge.

Don’t overpay

It might seem obvious, but ‘rookie’ commercial investors often overpay.

Now, I don’t mean if the asking price is $700,000, you shouldn’t be paying $750,000. I’m referring to possibly paying the price per square meter that is 10% or 20% above comparable sales just because there is a ‘long-term tenant’ in place paying 8% net!

You need to know where the value point is and ensure you are fully aware of the property’s comparable prices. Don’t become overly focused on the cash flow and lease structure.

Paying too much for a commercial property locks up your funds in a more rigid way than residential real estate. Banks are far more reluctant to provide equity releases or cashouts for commercial investing.

Do know your property and know the market inside and out.

There’s nothing wrong with being cautious when buying property.

Many new investors sign the dotted line without doing enough research on a commercial property. It takes time, resources and market connections to ensure you understand the full picture.

Any field of business requires training and homework and commercial investing is most certainly one of them.

Don’t miscalculate cashflow.

Many successful commercial investors buy, hold and rent out properties for the long term, ensuring they have enough cash flow for maintenance and other expenses. The savviest investors allocate their budgets, so there is sufficient coverage for costs like the mortgage, taxes, insurance and advertising costs.

When you don’t have enough cash flow, your property becomes a liability when it should be an asset.

You can no doubt glean from the above dos and don’ts there is a raft of aspects which need to be considered when investing in commercial real estate. But the rewards can be huge, you just need to know your numbers.

 

Share this