Understanding commercial leases
When leasing out your commercial property it’s important for both landlords and tenants to understand the relationship they are entering into and the rights and obligations they each have. The document that governs this relationship is usually a commercial lease.
So, what is a commercial lease?
A lease is a legally binding contract that outlines tenant rights to a property for a set term. A commercial lease is used when leasing property used primarily for a business.
You should never sign a lease without understanding all its terms and conditions, and nor should your tenants. If you don’t understand what you are agreeing to you could experience serious financial and legal problems.
Each property will have its own nuances, therefore it’s a good idea to ask your lawyer to prepare a tailored lease for each property. Ensure you understand each clause and the impacts before providing the document to your potential tenants.
Important issues to consider when entering into a lease
A commercial lease will usually contain terms dealing with the following items.
Rent: How much is the rent and when is it due? The amount of the rent will usually be calculated based on the area of the premises. This may not always be a simple as it sounds if the shape of the property is irregular or the area includes a lift, more than one floor, outdoor area or interior walls.
Rent Increases: Rent will usually increase annually during the term of the lease, with increases determined by a fixed percentage, be market based or tied to the CPI. It is common for CPI or fixed reviews to occur during the term of a lease and for a market review to occur at the expiry of the initial term and each option period.
Security Deposit: As the landlord, you can usually ask for some form of security from the tenant in case the tenant defaults on their obligations (e.g. not paying rent). The security is usually for an amount equal to 3-6 months’ rent and is by way of bank guarantee or security deposit. If the tenant is a company then personal guarantees from the company’s directors may also be required. The lease should also specify the terms regarding the return of the deposit.
Term of the lease: The lease should set out the length of the lease, any options to renew the lease and any terms relating to the renewal. Landlords will generally want a longer initial lease term (typically 3, 5 or 10 years) whereas the tenant is likely to want a shorter period (1-3 years).
Option to Renew: An option allows the tenant to continue leasing the property on similar terms at the end of the period of the lease for a further defined period and rent (subject to any review). An option gives the landlord potential greater security of income and the tenant the ability to make longer term plans for their business. Knowing the procedure for exercising the option, especially when the option can be exercised, is critically important.
Improvements: A lease should address what improvements or modifications can be made to the property, who will pay for the improvements and whether the tenant is responsible for returning the property to its original condition at the end of the lease.
Description of the property: The lease should clearly describe all of the property being leased, including bathrooms, common areas, kitchen area and parking spots. A plan of the property should also be included.
Signage: Any restrictions on putting up signs, such as those that are visible from the street, will be included in the lease. Also, check local zoning regulations to determine what other limitations may apply.
Use of the property: Most leases will include a clause defining what the tenant can do on the property (e.g. the type of business). A tenant should ask for a broad usage clause just in case the business expands into other activities. Tenants should ask the local council if their business can operate in the proposed location and also, consider the council’s development plans for the area.
Outgoings: The lease will set out who is responsible for costs like utilities, property rates and taxes, insurance, and repairs.
Insurance: You should contact your insurance company and discuss the clauses referring to insurance so you fully understand what is covered by the lease.
Exclusivity clause: This is an important clause for retail businesses renting space in a commercial complex. An exclusivity clause will prevent a landlord from renting space to a competitor.
Assignment and subletting: A tenant can maintain the right to assign the lease or sublet the space to another tenant. Usually the tenant is still ultimately responsible for paying the rent if the business fails or relocates, but with an assignment or sublet clause in place, the business can find someone else to cover the rent.
Maintenance and repair: The lease should clearly set out who is responsible for maintaining or repairing the property and the fixtures and fittings during the term of the lease.
Make good: A tenant should carefully review the make good obligations in the lease. Often these can be onerous and involve considerable expense on the tenant or the landlord having to reinstate the premises to their original condition to maintain the property’s viability at the end of the lease period.
Termination: The circumstances under which the lease will be terminated should be set out in detail in the lease.
Costs: The landlord may want the tenant to pay the costs of preparing the lease, this should be clearly set out in the lease.
Retail lease or general commercial lease?
The Retail Leases Act 1994 has specific legislation relating to retail leases. This legislation is designed to promote fair leasing arrangements, improve communication and provide access to low cost dispute resolution for the retail industry.
For a new retail lease, the landlord is legally required to give the tenant:
- a written lease with matters agreed to and signed off by both parties;
- a disclosure statement; and
- your State Government’s Retail Tenants Guide, which gives notice of some of the tenants’ rights and obligations and some commercial matters that the tenant should be aware of.
The disclosure statement, which outlines important information about the lease, must be in the prescribed form and contain a statement notifying the tenant that independent legal advice should be obtained. It would also normally include details about:
- the term of the lease;
- whether there are options for further terms;
- the occupancy costs for leasing the premises (including rent and any outgoings);
- specific information for shopping centre leases;
- tenant’s fit out requirements’ and
- if there are any relocation or demolition clauses.
Although many of the terms of a commercial lease are fairly standard, it is important that you fully understand your rights and obligations, especially the provisions which relate to retail leasing.
It is a good idea to ask your lawyer to explain what each clause in the lease means and to get their assistance in preparing the terms and conditions that suit you.