Clearing The Mist For New Landlords
Leasing commercial property is an entirely different story to renting residential and can be a daunting prospect, but there is good advice out there, writes Sally Lindsay.
28 February 2023
As residential house prices drop and landlords are hit with the first of the four yearly reductions in mortgage interest payments they are able to claim against their income, many are now considering investment in commercial property.
However, leasing a commercial property is an entirely different story to renting a residential property and can be daunting for a new landlord.
Although there are standard commercial leases available they are far more complex than a residential rental agreement, says LegalVision.
There are more decisions for landlords to consider to ensure they and their tenants are satisfied and happy with the lease.
Often when issues arise with commercial leases it is generally a result of poor documentation, which has usually been in place right from the start of the tenancy, says law firm Lockhart Muir.
LegalVision says before making an offer to lease it is vital a landlord considers the term they are willing to offer and whether they are also willing to offer options for renewal.
There are also other key issues to consider by landlords. The last thing a landlord wants is for the agreement to have missed an essential scenario that they may need to refer back to in the future. The Property Law Act governs a commercial lease agreement. Additionally, it can include various clauses the landlord has agreed with a
tenant. Lockhart Muir and LegalVision say the contract should include details such as:
1 Are the parties involved clearly identified in the lease? This might sound basic, but it is important all parties to a lease are accurately recorded. Failure can lead to questions surrounding the validity of the lease, and the ability to hold parties responsible under that document.
2 Description of the premises: Are the premises clearly described in the lease? Is there a plan depicting the area defined as the premises? Are there car parks included? The importance of accurately describing the premises and any car parks, with cross-references to a plan, which need to be included in the
lease itself, is key.
3 Term of the lease: Landlords typically like a longer lease, tenants a shorter one. Are there rights of renewal on the lease? If so, are these included in the lease document? A long-term lease will give your business a sense of security as you have bound the tenant for a longer time. This means a landlord will have a steady income from rent for some years, and there is a lower risk of vacancy.
4 Rent reviews: Are they CPI (consumer price index) reviews, market reviews, or fixed raises? If the rent is to be reviewed to “market” rates, does a hard ratchet or a soft ratchet apply? Many law firms and commercial leasing agents suggest a market review needs to be done at least once every three to five years. CPI or fixed raises might be acceptable each year, but every few years the rent should be reviewed to market to ensure it is in line with existing market conditions.
5 Is the business use clearly defined in the lease? Does it comply with council or other local authority requirements? Does it comply with the building’s body corporate requirements? Loose or vague business use descriptions can cause issues later in a tenancy. Lockhart Muir says it reinforces to clients the importance of ensuring the business use is accurately defined, and that it is compliant with the requirement of necessary authorities. Bear in mind, as a tenant, that changing the business use “down the track” requires the landlord’s approval.
6 Maintenance requirements: How often is the tenant required to paint and redecorate the premises? Or re-carpet?
7 Fixtures and fittings: What landlord fixtures, fittings and chattels are included in the lease? Are these clearly identified? Are these to be excluded from rent reviews?
8 Premises condition report: Make sure a report is included in the lease at the outset, or get it done as soon as possible on possession. This is a fundamental document, especially when the lease is coming to an end and the tenant is required to attend to reinstatement of the premises to its original condition. Issues continually arise with reinstatement, and the lack of an accurate premises description report is a major cause of arguments between landlords and tenants.
9 Outgoings: What outgoings is the tenant responsible for? What will the landlord pay? Make sure these are clearly set out in the lease, and that both parties understand them.
10 Responsibilities and obligations: In a commercial property lease it is essential to outline the landlord and tenant obligations. A landlord does not want to go back and forth with their tenant, organising who will pay for what repairs. Further, you need to ensure that the lease is clear on: what happens if the property is damaged, and who will be responsible for these damages. Examples where confusion can arise include air conditioning or exhaust venting, where it is difficult to know what is a capital replacement or maintenance repair issue. Generally, the landlord will be responsible for the basic infrastructure, but the tenant should be responsible for servicing, repair and maintenance. Such clauses will help protect the landlord if the tenant has damaged the property, as it may be unfair if the landlord has to bear those costs.
11 Security from tenants: A landlord may want security for the lease beyond merely a promise to pay from a company tenant, which may not have any significant assets backing its promise to pay over the long term. Tenants usually provide additional security through a bank bond or personal guarantee.
Bank bonds or bank guarantees are a financial agreement between a tenant and their bank where a bank will pay a specified sum to the landlord if the tenant cannot pay. The bank must release it immediately on instruction. Normally, the amount to be set aside for a bank guarantee ranges from three to six months’ rent, plus outgoings. It is strongly recommended that a larger bank guarantee be required, such as six months’ rent, if no personal guarantee is secured.
A personal guarantee is where a director (or directors) of the tenant company agree to personally pay for any debts they incur, such as failing to pay rent or utilities. A landlord can ask for more security if the lease agreement carries a high risk. Usually, tenants leasing for the first time, or having a weak leasing history, will indicate
Security can help ensure that a landlord does not take responsibility for any of the tenant’s debts and that their interests in the property are protected. However, having a clause requiring security from a tenant may put off prospective tenants who do not want to provide security. Therefore, while it may protect a landlord, it may be harder to find tenants, depending on the landlord’s requirements.
‘It is essential to outline the landlord and tenant obligations’
12 Fit-out contributions: In a difficult leasing environment some landlords are willing to consider offering fit-out contributions. A fit- out contribution is where landlords contribute to the upfront costs of the fit-out to encourage tenants to sign the lease. This is preferable to a discount on the rent, given the value of the property is often calculated as a multiple of the rent paid. It must be made clear in the lease the tenant must pay back the fit-out contribution if the lease ends early
or is assigned. This is because a landlord is only likely to recoup their investment if the tenant stays for the full term.
13 Make good clause: This means the tenant must return the property to its condition at the beginning of the lease. It includes repairing any damage done to the property and undoing any renovations. This is helpful, especially if the tenant has made a significant change. A make good clause means the landlord does
not have to invest money in returning the premises to their original colour and condition.
A commercial lease agreement is a legally binding agreement between the landlord and tenant. Landlords should have the documents reviewed by a lawyer who specialises in real estate law and leasing. By checking the contract, the landlord can amend and negotiate aspects they may not have considered earlier. Doing so will
ensure the lease has clauses for all relevant situations and best protects the landlord’s interests.
Lockhart Muir says landlords should make sure each relevant milestone is documented. Rent reviews, rent renewals, variations and extensions all need to be accurately documented and signed by all parties to the lease.