Focus On Leases
Commercial leases are complex and have far-reaching consequence. Editor and barrister Ian McIntosh provides his beginner’s guide to leases.
1 February 2020
Recent years have seen a slew of regulatory and policy changes which impact on residential property investors. And that’s motivating growing numbers of investors to exit the residential market in favour of the commercial market.
But investors who make that move have to be aware that being a commercial landlord is very different to being a residential landlord. First up, they will need to become familiar with the meaning and effect of commercial lease documents.
To that end, this article provides a basic overview of commercial lease documents and the meaning and effect of some of the terms and conditions commonly included in them. It also points out some of the practical considerations that investors should take into account before they sign on the dotted line.
Essential Lease Terms
A commercial lease must contain the following terms expressed in writing:
• The parties (ie: the landlord and tenant) and the premises to be leased must be clearly identified.
• The term of the lease (ie: its start date and duration) must be certain, or capable of being made certain (for example by one party giving notice to the other party that the lease will end on a certain date).
• That rent must be paid (and the rental amount and instalment periods should be specified).
However, the parties can agree to add other express terms to the lease document. It is also worth pointing out that the Property Law Act 2007 allows a range of covenants to be implied into leases unless they are specifically replaced by express covenants.
These implied covenants should be excluded by express terms in a lease and in the interest of ensuring that the terms of a lease are certain. It is advisable to have a clause in a lease that expressly excludes them. (This type of clause is included in the Auckland District Law Society’s (ADLS) Deed of Lease which is discussed below).
Agreements To Lease
When commercial real estate agents are engaged to sign up tenants, they will prepare an Agreement to Lease.
A good, and commonly used Agreement, is the ADLS standard form of Agreement to Lease.
This document should, at a minimum, set out the basic terms and conditions that the landlord and tenant have agreed on. It should include a description of the parties, length of the lease, the commencement date, the amount of rent to be paid, and a description of the premises that are subject to the lease.
Whether or not the ADLS Agreement is used (and there are other Agreements available – for example the Property Council New Zealand also has an Agreement to Lease), the Property Law Act stipulates that, if it is to be enforceable, an Agreement to Lease must be in writing and signed by the parties.
Deeds Of Lease
Once an Agreement to Lease has been signed it is a binding contract. However, under the ADLS’s Standard form Agreement to Lease, there is another step in the process and the parties also have to sign a formal Deed of Lease.
A Deed of Lease is a formal document that provides a detailed record of the rights and obligations (including the terms and conditions in the Agreement to Lease) of the landlord and tenant. In order to have legal effect it must be signed by the parties and their signatures must be witnessed.
The most commonly used Deed of Lease is the ADLS standard Deed of Lease 6th Edition. It contains a standard set of terms and conditions with which most lawyers, real estate agents and experienced landlords will be familiar.
The terms and conditions anticipate many of the issues that are commonly encountered in commercial tenancies. It is also updated periodically to take into account new developments – like the impact of the Christchurch earthquake on the relevant law.
For this reason, the ADLS Lease is a sound document that can be tailored to meet the specific requirements of a range of commercial tenancies. For example, the standard terms in the ADLS Lease cover the following important issues:
• The requirement that tenants pay the annual rent, by equal monthly instalments in advance, on the dates specified in the lease.
• The need for a landlord to have insurance cover that is sufficient to cover the cost of replacing a leased building. (Generally, the tenant will pay the cost of the insurance premiums and excess on insurance claims not exceeding $2,000 per claim.)
• The need to ensure that tenants have the right to quiet enjoyment of the leased premises.
• The extent of the tenant’s obligation to meet care and maintenance costs relating to the premises and grounds.
• The landlord’s right (after giving written notice to the tenant) to enter and inspect premises to ascertain whether repairs need to be done and to pass the cost of those repairs onto the tenant.
• The landlord’s right in emergencies to enter, inspect and carry out remediation work on the premises with a consequent reduction (or cessation of payments in some circumstances) of the rent and outgoings payable to the landlord if the tenant’s use of the premises is disrupted or if the tenant has to vacate the premises).
• The landlord’s obligation to repair and maintain the leased premises. (Some of these costs can be recovered from the tenant if they are outgoings under the lease.)
• The landlord’s obligation to carry out structural repairs to the exterior of a leased building including the roof and to ensure that the premises are protected from water ingress. (Note that in cases where the repairs are not minor in nature the costs must be met by the landlord.)
• Rent reviews (which should be conducted with reference to the market and/or the consumer price index).
• The right of a tenant to ask the landlord to agree to allow the lease to be assigned to a new tenant. (This request is not to be unreasonably refused and a document called a Deed of Assignment will need to be executed.)
• The ability of the landlord to require a personal guarantee for payment of the rent and performance of the covenants in the lease. (In cases where the tenant is a company it is common to seek a guarantee from the directors or shareholders of a company.)
• A restriction that confines the ability of the tenant to use the premises for anything other than business use.
• The term of the lease and provision for renewal or extension of the term.
• The procedures to be followed when a tenant wishes to make alterations or additions to any part of the premises.
• The requirement that a tenant, no later than the end of the term of the lease, reinstate the premises and make good any damage caused by the removal of the tenant’s chattels.
• The procedures that must be followed by landlords when they wish to cancel a lease as a result of a tenant’s failure to pay the rent on time or when the tenant breaches another obligation under the lease.
While the ADLS Deed of Lease is in common use, it is not the only standard form commercial lease available in New Zealand. Other standard form leases that deal with specific types of commercial properties can also be used as precedents.
Some examples are the Property Council’s Standard Office Lease, Retail Property Lease and the BOMA Industrial Lease. Investors might want to consider whether these leases are better suited to their purposes.
Commercial leases are complex documents and the consequences of entering into them are far reaching and costly. For that reason, there’s a long list of matters that investors should address, preferably with their lawyer, before they sign an Agreement to Lease or a Deed of Lease.
Firstly, they should establish whether a tried and true precedent, like the ADLS Agreement of Lease, has been used as the basis for the terms of the lease. They also need to ensure all the terms of the lease are in written form. It’s important to ensure the parties understand who pays what in everyday and emergency situations.
A prospective tenant’s creditworthiness must be checked to get a clear picture of their business experience and track record. This will help to ensure that the risks of entering into Agreements to Lease and Deeds of Lease are managed.
An agreed business use should be set out in detail in the lease. And a guarantee from the directors or shareholders of a tenant that is a company should be obtained.
Investors should get legal advice on the circumstances that would enable them to refuse to allow the lease to be assigned to a new tenant – and on the terms and conditions of a Deed of Assignment.
It is important to make sure that the lease is very clear about who pays what in relation to reinstatement of the premises and removal of the tenant’s chattels at the end of the lease. So it’s well worth obtaining a Premises Condition Report at the start of the lease and appending it to the lease. Doing so means there is a record of the condition of the premises before the tenant makes any alterations to the property.
Going forward, once the lease has been signed it’s important for investors to review their insurance regularly to ensure that the amount of cover keeps pace with the ever-increasing costs of replacing a building. Finally, if a tenant is in default under the lease, landlords must make sure they follow the procedure for cancelling the lease to the letter.
Please note that the content of this article is general in nature. It is not intended as a substitute for specific legal advice on commercial property leases and should not be relied upon for that purpose.