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 stronger long-term position when negotiating a commercial lease.*
Commercial leases are usually negotiated on a per-square-meter basis. The annual cost of the lease is usually determined by multiplying the square meter of the premises by the asking price per square meter (psm).
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 term of the lease 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. These deposits are held by the landlord 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 length of the lease 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 the security of tenure. 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 businesses 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.
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 offer a contribution towards the costs of your fit out. You should note often 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.
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 landlord’s consent. There are often conditions attached to this consent process.
9. Alterations and improvements
Most commercial leases specify that tenants require the consent of the landlord 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 at the end of the lease the tenancy must be brought back to a vacant shell. 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 certain 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.
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.
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. Retail shop leases are governed by different rules.