Negotiating a commercially viable lease requires knowledge and understanding of lease clauses’ key terms and conditions.
Some key terms and conditions typically included are:
- lease duration (or term) & options to renew
- rent and rent reviews
- permitted use
- tenancy mix & competition
- costs
- repair & maintenance
- compensation for disruption caused by the landlord’s works
- assignment & sub-leasing
- default and breaches
- redevelopment & relocation
- termination
A proposed lease is likely to include other terms and conditions.
TIP: Before signing a lease or related documentation, taking possession of the premises or paying any monies, we suggest you obtain independent legal, business and financial advice.
Lease duration and options to renew
Ensure the duration, or term, of the proposed lease is long enough for you to recoup your investment and make the required profit. Remember, once your lease has expired, your landlord is under no obligation to renew, and you may need to find alternative premises.
Options
Ensure the proposed lease provides you with renewal options to continue trading from the premises after the end of your initial term.
If you are starting in your business, so without a leasing history, you may decide to negotiate a short initial term and gradual options to renew, like a one-year lease followed by a two-year option.
If your business is already established and you seek security, you may prefer to negotiate a longer-term lease, for example, a two-year lease followed by three-year and five-year options.
Under the Commercial Tenancy (Retail Shops) Agreements Act 1985 (CT Act), a tenant entering into a new lease for a shop has the right to a minimum tenancy period of up to five years. If the lease does not provide for this tenure, a tenant may extend it as a statutory option.
To exercise this option, a tenant must complete a Notice of Exercise of Option and submit it to the landlord 30 days before the end of the lease.
Exercising your option
Your lease will include guidance on informing the landlord that you want to exercise your option. You’ll exercise your choice in writing three to six months before the end of the lease.
The CT Act requires landlords to provide at least 6-12 months’ notice before you exercise your right to renew your lease.
TIP: Action failure by the due date or as included in your lease may result in the lease ending.
Rent and rent reviews
It would help if you negotiated rent and frequency of rent reviews with your landlord. These rent reviews are usually annual, but you can arrange them less frequently.
Leases covered by the CT Act must have one basis for calculating a rent review.
Some common types of rent reviews to choose from are:
- consumer price index (CPI)
- fixed percentage increase
- fixed amount
- market rent
Ensure you can afford proposed rent increases throughout your lease and any renewal period.
Market rent
Suppose a market rent review applies upon exercising an option to renew your lease. Before proceeding, it is important to establish the market rent with the landlord to ensure the proposed rent is acceptable and commercially viable.
Percentage rent
Avoid renting reviews based on a percentage of your turnover when negotiating a lease. In other words, you agree to pay a base rent, and once you reach a certain level of turnover, you’ll spend additional rent based on a turnover percentage.
If the lease includes this clause, you must provide details of your turnover to the landlord. Avoid having this info used against you later, in negotiations or selling the business.
Permitted use
A lease will usually include a clause of permitted use of the premises.
Permitted use allows you to undertake the activities required to operate your business and includes the goods and the services you will provide.
Consider what you may want to offer in the case of business expansion. If you are only permitted to sell ice cream, this could cause problems if you add pizza or smoothies to your a la carte menu.
Permitted use may limit your opportunities to assign the lease to another entity if you sell the business or leave the premises before your lease ends. It’s best to negotiate a permitted use that is s broad enough to protect future business interests.
Tenancy mix and competition
Consider the variety of tenants in a shopping centre or high street precinct. Combining businesses should complement rather than compete with your business.
Including an ‘exclusivity of trade’ clause in your lease is a good idea. It prohibits direct competition by giving you the sole right to sell a particular product category or conduct a type of service in the complex controlled by the same landlord.
Anchor tenants
You may be drawn to particular premises with a significant tenant in the same location, like a supermarket chain or department store. These are known as anchor tenants. Your business may even rely heavily on the foot traffic they generate. If this is the case, negotiate a clause in the lease giving you the right to terminate the lease or get a rent reduction if the anchor tenant leaves the building or shopping centre.
Costs
You must consider other costs associated with commercial leasing premises in your negotiations. These costs are additional to rent and are often significant. They may also be ongoing and increase during the lease, such as:
- operating expenses or outgoings
- insurance
- legal costs
- security bond
- fit out
- refurbishment
- marketing & promotional funds
Operating expenses or outgoings
Operating expenses are the landlord’s costs in operating, maintaining or repairing the leased premises. These costs can include land tax, council rates, water rates, security, cleaning common areas, and general repairs and maintenance.
Be aware of any operating expenses required to pay before you sign the lease. Why? They can add significantly to your overall costs.
It’s also wise to negotiate that you won’t be obliged to pay for any operating expenses incurred by the landlord. If this isn’t possible, limit them to only those that will benefit your premises. Also, negotiate a maximum increase over the term of the lease.
Expect costs such as structural repairs and capital items (assets) to be the landlord’s responsibility. Why? The landlord has the ongoing benefit of these assets.
Leases covered by the CT Act must itemise any operating expenses you will be obliged to contribute towards.
The lease should also cover your access to invoices and receipts to confirm actual operating expenses.
Insurance
You may be required to take out insurance to cover building damage and public liability. Avoid any indemnity clauses that require you to compensate the landlord in the event of any unlawful act, loss or damage.
These clauses may breach your insurance policy, so it’s wise to discuss any insurance clauses with your insurer before signing off.
Legal costs
Both parties may cover the legal costs of negotiating and preparing the lease. It is a good idea to negotiate that each party pays their legal bills or, at the very least, limits your contribution to the landlord’s costs.
You should also avoid clauses requiring you to pay the landlord’s legal costs in a dispute.
Under the CT Act, a landlord cannot require you to pay legal costs associated with:
- the negotiation, preparation, execution, renewal or extension of lease
- obtaining consent to lease from financial lenders (if property is under mortgage)
- complying with the CT Act
The landlord can claim legal costs and other related expenses of an assignment of lease or sub-lease from you.
Security bond
You may need to pay a security bond at the beginning of a lease. However, the amount is often negotiable. If you agree to a security bond, the lease will outline the conditions for the bond use, withholding or repayment.
Fit-out and condition of premises
‘Fit-out’ is the action of preparing a leased premise for occupation. This is according to what is required by the tenant and agreed to by the landlord. It can include installing shop fronts, wall or floor coverings, fixtures, and fittings.
You may negotiate responsibility for the fit-out or parts. Ensure the lease specifies the fit-out requirements and who is responsible for the costs. Negotiate firmly so that the items you purchase for fit-out remain your property at the end of the lease.
Fit-out costs can be significant. Allocate a generous budget when considering leasing commercial property.
Under the CT Act, you are not obliged to contribute to the cost of the landlord’s finishes, fixtures, fittings, equipment or services unless notified of these costs in the Disclosure Statement provided at least seven days before the lease is finalised.
TIP: Allow for delays in completing a fit-out, especially regarding seasonal shortages of tradespeople, which are common reasons for these delays.
Refurbishment
You may be instructed to refurbish the lease premises during your tenure, especially in shopping centres that are kept updated. Negotiate refurbishments to occur no more than every five or six years.
Under the CT Act, a clause requiring you to refurbish or refit the premises is not legally valid unless sufficient detail is included in the lease. This consists of the extent, timing and nature of the refurbishment or refit.
Marketing and promotional funds
You might be required to contribute to marketing or promotional funds under your lease, particularly if situated in a shopping centre.
Determine your contribution cap for marketing and promotions before entering your lease. Negotiate terms to limit your contribution and allow input on how the funds are spent.
Repair and maintenance
Clearly outline responsibility for repairs and maintenance in your lease. Negotiate the landlord’s responsibility for the building’s structure and important items. This includes roof, walls, exterior fittings, air-conditioner, gutters and downpipes, plant and equipment they own.
You, as the tenant, may be responsible for repairs and maintenance of internal surfaces and fixtures like doors, windows, floor coverings and equipment provided by the landlord for your use.
Negotiate with the landlord to replace equipment like air-conditioners and sprinklers when their useful life span is over.
TIP: Arrange the premises to be independently inspected before entering the lease. Include photographs in your condition report. This will avoid future disputes around the condition of the premises and equipment
Compensation for disruption caused by the landlord’s works
You may be entitled to compensation if your landlord carries out works that disrupt your business (including general maintenance work or building redevelopment).
Assignment and sub-leasing
You may need to assign the lease if you decide to sell your business or cease operating. In this case, you will need the landlord’s permission, so ensure your lease stipulates that they cannot unreasonably withhold consent.
Reasonable grounds for refusing the re-assignment include the prospective new tenant having poor credit or business history or intending to use the premises for a purpose other than what is permitted in the lease.
If you assign a lease, you may be liable if the new tenant defaults on their payments. However, it is illegal for clauses stating the landlord can withhold consent unless a tenant agrees to accept liability in retail leases under the CT Act.
Leases not covered by the CT Act need surety that tenants may be released from any liability after the date of assignment.
If sub-leasing part or all of your premises, you will be liable for the lease and may need to pay rent if your incoming tenant fails to deliver. It is vital to undertake a credit check so you can ensure that the incoming tenant meets all legal requirements.
If under the CT Act as a sub-lease, you assume a landlord’s responsibilities. You will need to provide appropriate documents, including a signed disclosure statement and a tenant guide to the new sub-tenant.
If you assign a lease or proceed with sub-leasing, you may need to pay the landlord’s legal costs and other associated expenses.
Defaults and breaches
You will default your lease if you do not pay your rent on time, as it allows the landlord to take action to recover the rent. In many leases, the landlord has the right to enter the premises and change the locks without notice.
The landlord may claim the loss of rent up to the end of the lease period and any costs associated with re-letting their premises. If the premises are re-let at a lesser rate, the landlord may claim this plus any other costs associated with defaulting.
When negotiating your lease, ensure the appropriate clauses specify that you must be given written notice of any default and at least 14 days to rectify the default before the landlord takes any action against you.
You can also breach your lease if you do not undertake specific requirements. This includes failing to maintain the premises. Negotiate written notice in your lease and sufficient time to rectify any breaches before the landlord takes action against you.
Redevelopment and relocation
A redevelopment clause allows a landlord to end a lease early if significant works to renovate or redevelop the premises are needed. If this happens, you may need to relocate to alternative premises, which could severely affect your business.
It would help if you negotiated to remove the redevelopment and relocation clauses from the lease. If you can’t, ensure the lease provides compensation for loss of trade associated with relocating your business, payment for relocation and other costs.
Consider negotiating a reduction in rent in this scenario.
There are detailed requirements for leases covered by the CT Act regarding the redevelopment and relocation of a tenant’s business and early termination of a lease.
TIP: Consider the risks associated with redevelopment and relocation seriously. If you cannot negotiate adequate compensation, consider your business’s potential risks to make it worth entering into the lease.
Termination
When negotiating a lease, check whether any clauses allow the landlord to terminate the lease early and try to arrange to have them removed if there are.
Researching the area, landlord and lease details
Before signing a commercial lease agreement, you’ll have to spend time researching. Follow these steps to help this often time-consuming process.
- Understand the area.
When looking for new premises, analyse the area and get a good idea of potential clientele. Location is everything for a small business’ success, so take the time to find the right new home for your business. Give yourself enough time if your current lease’s end is near.
- Find out more about the landlord and building owner.
Don’t overlook learning more about the landlord and building owner. Often, your direct landlord may not be the true building owner, so it’s wise to find out as much about them as you can. Make sure you know who they are, their financial situation and whether they’re reliable with payments.
If the landlord fails to make their payments to the building owner or make mortgage payments to a bank, you may be evicted in the event of foreclosure. This is even if the business has been on time with every amount. Companies may conduct a public-record search in this case. You may also request documents related to the landlord’s limited liability company or business entities to assess whether they’re an ideal partner for your business.
- Research zoning laws.
While your landlord may designate your space, you must ensure their aims are consistent with your council’s laws. There are situations where a landlord or building owner may think they can lease their space to a certain business type without matching standard zoning laws. By aligning these, you can ensure your business can operate without legal breaches within your jurisdiction.
- Learn about nuisance laws and the environment.
Before signing a lease, you need to ensure your business can operate to its fullest capacity once you open your doors. Many leases have extensive points on smells, noise and equipment.
It’s also vital to research basic environmental laws before you sign anything. Landlords can overlook these laws and may be used against your business.
Key takeaway: Do your due diligence on the property before signing a lease agreement. Research the local area, the zoning laws for the site, the landlord, and any other council and environmental laws for the property.
Important commercial lease statutes to keep in mind
Rent structure is the most important aspect of any lease. By concluding how much you pay per month and how much your rent will increase each year, you can better determine budgets and understand whether you can stay in business on your current premises.
Lease terms are also critical. Consider short-term and long-term leases. Long-term leases are a great investment if you’re opening a business in an emerging area. Short-term leases allow you to move locations or close your business if it doesn’t perform as you hoped.
Ask your potential landlord how they pay the following expenses:
- Property taxes
- Insurance
- Security
- Maintenance (both interior and exterior)
- Repairs
- Parking
- Local nuisance laws (noise or smell)
- Utilities (gas, electric, water)
- Modifications
When you’ve established some pricing and term structures, dive into some of these less obvious details. Here are some examples of statutes to be aware of before you sign a lease:
- Transfer structure. How will your lease be transferred if you want to leave the space or your business closes? There are generally two structures for sharing: assigning the lease and subletting. Assignment of lease is where the entire lease is transferred to a new tenant. Subletting is when a current tenant keeps their name on the lease but receives payment from a new tenant and then transfers that money to the landlord. In both cases, you must have prior written consent before the transfer occurs.
- Personal exposure. You may be required to sign a personal guarantee for a commercial lease. These agreements mean you’re personally responsible for certain aspects, even if your business defaults. You should work with legal counsel to negotiate this clause.
- Holdover rent. This is a rent increase when a tenant overstays the lease. When businesses move spaces, they might linger longer while the new one is being set up. Landlords may include a clause stating that the tenant is responsible for up to 250% of their monthly rent payment in this situation. Staying beyond your time will cost you a lot of money.
- Nondisturbance agreement. If the landlord fails to pay their mortgage, your business will still be evicted even if you make all of your payments. You’ll then be permitted to stay and continue paying whatever entity has taken over the building from your landlord.
TIP: While reviewing the lease, note additional clauses, such as transfer structure, personal exposure, holdover rent and nondisturbance agreements. And how payments are made.
Everything can be negotiated.
While these are things to be aware of, you can negotiate many aspects of your lease. Work with your potential landlord and an attorney to ensure you get the best deal.
Commercial leases have fewer legal protections. This is because consumer laws that apply to residential lease agreements don’t cover commercial leases.
TIP: Negotiate every term of the lease because many aspects are negotiable.
Commercial lease agreement terms to know.
Rent amount/base rent. The amount is calculated based on the square footage of the space. Cross-check the number the landlord is using. This rent does not depend on revenue.
Usable square feet. Refers to the size of the space actually reserved for the business as a tenant in cases of shared spaces.
Rent increases. Usually based on a percentage of total rent, which can change yearly. You may negotiate to cap rent increases.
Security deposit. The amount needed to hold the space until the paperwork is finalised. It should be specified both ahead of time and in the lease agreement.
Length of the lease. Typically between three and five years. Commercial landlords prefer longer lease terms, and the agreement will specify the start and end dates.
Improvements. The part of the commercial lease agreement that lays out the types of improvements and upgrades that can be made and who is responsible. Many aspects of this section may be negotiated.
Bottom line. Ensure you understand all terms in a commercial lease contract and feel comfortable before signing.
Grant of lease. The clause stating that the landlord will turn the property over to the tenant once all conditions have been met, and the tenant accepts the property.
Commencement date. The date the tenant takes over the property and the first day the tenant becomes responsible for paying rent and maintaining the property.
Extension. A flat fee or percentage of the monthly rent.
Taxes. All taxes associated with the property, including property taxes and real estate taxes and who is responsible for payment.
Obligation for repair. This clause states the repairs the landlord is obliged to make good the things crucial for operating the property. It also outlines the repairs that tenants are responsible for.
Permits. Both parties must acquire the necessary permits and licenses to make improvements or repairs to the property.
Covenants. These terms differ between the tenant and the landlord. Each has a separate set of covenants, by which they may state the tenant must pay rent, even if the landlord does not uphold some of their obligations per the lease.
Indemnity by tenant. This clause removes all liability from the landlord in the event of loss, injury, claims or damage unless they are a direct result of willful acts, gross negligence or omissions on the landlord’s part.
Rent abatement/adjustment. This clause states whether the rent will be adjusted or abolished in the event of property damage from a fire, earthquake or other natural disasters.
Condemnation. An important yet overlooked clause that determines what happens if a government agency takes the property for public use or condemnation.
Option to purchase. A clause that states whether the tenant has the right to buy the property during the lease at an agreed price. It isn’t mandatory, but it is a good idea to include it. The clause may state that the tenant does not have the right to purchase the property during the lease term.
You can read more on commercial leasing in our blog section and head to our property management page for more information.
