Understanding Commercial Leases
The decision to lease commercial premises is usually a big one. Before you take this important step, you need to understand the lease you are signing. This article will help clarify some of the commonly misunderstood or overlooked clauses of your commercial lease.
Commercial Leases are complex and difficult to understand. Auckland District Law Society, (ADLS) leases are often used as a standard document, however, there are many different versions depending on when your lease was entered into and generally there are further terms or amendments. Not all landlords use ADLS, and your lease or license may be in a completely different format. Regardless of what type of lease you have there are always terms that are specific to your agreement.
CP Pro Tip: Any provisions in your commercial lease can be negotiated with the Landlord before signing the lease. CPP can help you by reviewing your lease and negotiating with your landlord on your behalf.
You may ask, “Why do I need to understand my lease, can’t I just rely on my Lawyers advice?”
Of course, it is important to get legal advice before signing a lease, however, it is important for you to understand the terms of your lease as well for the following reasons;
Negotiate. Before you sign a lease you have the ability to negotiate with the landlord. Understanding your lease allows you to decide which provisions you would like to negotiate. Maybe you want to offer a bank bond instead of a personal guarantee, or limit your guarantee to a certain amount . You can negotiate on types and frequencies of rent reviews or any of the other clauses.
Costs. There are additional costs included in most leases that you may not be aware of.
Rights. It is important to know your rights so that your lease so that you can exercise them when necessary. Many tenants don’t understand the process for contesting market rent reviews. Rent is such a major business expense and contesting market rent reviews allows you to ensure you are paying a fair rental.
Flexibility. Having your lease align with your business plan is valuable. You may be hoping to increase your operation within 3 years, so you might need a break clause half way through your first 6 year term. Or you may want an extra right of renewal if you are planning to sell the business. Prospective purchasers predominantly prefer longer leases in place when they invest in a going concern.
Here are some common provisions that are often included in leases but misunderstood by tenants.
Costs
Rent and outgoings are the standard lease costs. Carpark rent, signage rent or capitalised works costs are also common. Other than the rent and outgoings which are recorded in the first few pages of the lease, (called the First Schedule), you may also be up for the following costs;
Repainting: Clause 3 covers all of the maintenance items you are responsible for. These are usually included in the annual outgoings budget and billed monthly, however if your Property Manager does not make an allowance for periodical repainting of the building, you may be up for this additional cost when the building is repainted. Commercial buildings commonly need repainting every 8-10 years. If your building is not painted there may be cladding repairs required periodically. Check if your Property Manager has an external maintenance fund so that you know they are putting aside funds for repainting or any other major expense that is a tenants cost.
Insurance The First Schedule also details the types and amounts of insurance the the tenant pays through the outgoings, and the Outgoings Clause 3 details the excess on claims. The tenant is normally responsible for the excess of any insurance claim, regardless of who is at fault.
Refurbishment of your internal Premises: You also may be required to periodically refurbish the interior of your premises. Check for this under the “Maintenance and Care of Premises - Tenants Obligation” clause. Often there is a clause about carpets, repainting or even periodical upgrades to the premises.
Legal Costs In general the tenant will pay the landlords legal costs for an assignment of lease, however the tenant can also pay for the landlords legal costs for other documentation, like variations and renewals.
Insurance
Landlords insurance covers the following;
Replacement insurance for the building envelope and any of the Landlords fixtures.
Loss of rents and outgoings for a period of time (usually between 12-24 months), to cover your rent payment if the building is not able to be occupied after fire, flood, earthquake etc.
Public Liability Insurance
The Landlords insurance does not cover the following;
All fitout, contents, stock, and signage, or anything that you own.
Business interruption insurance for your loss of income if you can not operate for any reason.
Your companies public liability insurance.
You should always consult your own insurers to make sure you have the correct cover for your business.
Make Good
At final expiry, the current tenant must return the premises back to the condition it was at the start of the lease. This is a costly exercise and if the lease has been assigned to you, you will also need to repair any damage and remove chattels installed by the previous tenants. If you are entering into an assignment of lease and there is no premises condition report attached to the lease, make sure you understand your obligations regarding make good. You are within your rights to request that the landlord provide a summary of your make good obligations as part of your due diligence. The cost of this liability should be reflected in the purchase price of the business.
Check out my article on tenants Make Good Obligations in the CPP Knowledge Library for more information on this topic.
Rent Reviews
There are many different types of rent reviews, the most common are either based on the cost of inflation or the increase in the market value of your premises. Here are a few that you are likely to come across.
Market: Based on the current market rental for a unit of a similar size, in a similar location and with similar amenities. The landlord should provide you with an independent valuers certificate as evidence of the proposed market rent. Generally the tenant has around a calendar month to contest the rent review but this can vary so check your lease. To contest the rent review you normally just need to notify the landlord in writing that you do not accept the rent review. You could propose a compromise and hopefully you and the landlord can negotiate to come to an agreement. If you can not agree, then you are obliged to provide your own valuation. Normally after this has been done the two valuers will try to agree a fair market rent. If that fails then you and the landlord can enter into arbitration. This is a costly and lengthy process and I recommend you avoid it if at all possible. Until you reach an agreement the landlord is able to charge you interim rent which is detailed in the lease, and is generally the mid point between the two valuations. Once the rent review is settled the rent is adjusted to the agreed rent from the review date and the tenant pays the difference if the agreed rent is higher than the interim rent or receives a credit if the agreed rent is lower than the interim rent.
CPI: This is based on the cost of inflation since the last rent review date. The best way to calculate this is by using the Reserve Bank Inflation Calculator. This can also be CPI + 1% for example, which means you calculate inflation, say 6% for the last two years, and add another 1%, so your rent increase will be 7%. As this type of rent review is based on the increase in inflation, which is not open to interpretation, tenants can not contest CPI reviews. However you may still request that your landlord reduce or delay the increase if the increase is not affordable. Most landlords are happy to consider these requests, especially for tenants who have performed well for several years.
Fixed: This is the simplest type of rent review, and often is an annual fixed increase of say 3%. Easy to calculate, no surprises.
There are many variations of these reviews and other types of reviews that are less common. If you have a question about your rent review please contact us by email.
What if I am in breach of my lease?
A breach of lease can be for non-payment of rent or other costs, failure to maintain or repair your premises, voiding insurances or any other action that is in breach of your lease terms. If you are in breach of your lease the action your landlord can take will depending on the type of guarantee you have given and your lease terms. Some of the action the Landlord can take on breaches;
Charging Interest on arrears
Cancellation of your lease
Legal Action, including bankruptcy proceedings or claiming against your assets if you have a personal guarantee in place
Calling up your bank bond guarantee if you have one in place
If you are in breach of your lease the landlord must give you notice and time to remedy the breach. If this happens to you and you can not remedy the breach straight away, contact the landlord and try to come to an agreement regarding remedying the breach. This may be a payment plan or a compromise with regards to the work they are requiring.
Signage
You likely need the landlord to approve your signage design, where and how it is installed and they will also make sure it is installed safely.
There are many more clauses in your lease, and every lease is unique so I would struggle to write about them all. I do encourage you to take the time to read and understand your lease, or get someone to review it for you before you sign. This will make your relationship with your landlord much clearer and easier.
Make sure you also get your property lawyer to thoroughly check your lease before you sign.
CPPro offers a tenant representation service if you need help negotiating with your Landlord or reviewing your lease.
My initial consultation is always free. Email me to see how I can help.
Kirstin
The Commercial Property Knowledge Library is a free resource to help Tenants and Landlords achieve the best results for their businesses. If there is a topic you would like me to add to the library, please email your question to kirstin@cpp.nz.
Disclaimer: This advice is based on general New Zealand lease agreements including current and previous versions of ADLS. All leases are individual so this advice may not apply to your specific agreement. You should always take legal advice before entering into any formal agreement for lease of commercial premises.
