Sweet Spot negotiating a Commercial Lease agreement

Negotiating a commercial lease for the first time can be a little daunting. But like anything, it becomes easier once you’re familiar with the language and customs. We’ve outlined a list of the important factors to consider when you’re thrashing out the lease with your Landlord. It will help you to find that Sweet Spot where you both get a good deal out of the arrangement.

Being familiar with the language and customs of commercial leasing will give you greater leverage when negotiating a commercial lease with your landlord. It will help you to find the sweet spot where you are both happy with the deal and this is the best way to start your relationship.

Rent free / reduced rent period

Often a landlord will offer incentives to lock in a high quality tenant. Sometimes the incentives are tied in to longer lease periods, to afford the landlord the security of rental return.

Even if your potential landlord isn’t offering incentives straight up, don’t let this stop you from asking. Try to negotiate a rent free period (say 3 months’ rent free) or a percentage off the annual cost for the first year (for example, 20% reduced rent). It never hurts to ask and if they say no – you haven’t lost anything.

Fit-out

You know the work required to customise the premises for the specific requirements of your business – now just make sure you get the landlord’s approval to undertake these works before you sign the lease. You should also seek access to the premises before you start paying rent to undertake your fit-out works.

If the landlord has agreed to undertake certain fit-out works to the premises (painting, electrical, lighting, installation, etc), make sure you document the works in the lease. Most Australian retail lease legislation states that a tenant does not need to start paying rent until the landlord has substantially complied with its fit-out requirements.

Permitted use

How do you intend to use the premises?

Most leases have a ‘permitted use’ clause that restricts the tenants use of the premises to the permitted use only. Get approval from the landlord up-front for your permitted use and while you are at it, try to negotiate as wide a scope of the permitted use as possible.

For example, instead of a very restricted definition of ‘manufacture of light bulbs’, why not: ‘manufacture of goods’, or ‘any use allowed by law’. This will enable you to expand your business activities in the future if you decide to grow or diversify your business.

A wide permitted use will also come in handy should you wish to assign or sub-let down the track, as any intended assignee or sub-tenant will also need to act within the scope of the permitted use specified in the lease, unless the landlord agrees otherwise.

Length of the lease

If you are setting up a new business, think about negotiating a short lease term rather than locking yourself into a long lease.

You may want to think about asking for options, which gives you the right to extend the lease after the initial lease term expires if things are going well for your business, but at the same time, you are not locked in to taking up the option if things are not working out as you hoped. An example might be an initial term of 1 year, with five 1 year options after the initial 1 year term has expired. Or an intial term of 3 years, with 3 options to renew.

What is best for you will depend on your circumstances.

Cost of the lease

If the rent is based on an amount per square metre, you should double check the area of the rented premises.

Remember, the cost of the lease is not just the starting base rental amount. Check for costs hidden in the fine print, such as outgoings, maintenance, local government rates and charges, taxes, security fees, cleaning, water charges, sewerage and drainage rates, insurance, management fees, legal fees, electricity, garbage removal, air conditioning, common area maintenance fees etc.

Some landlords chose not to charge extra for outgoings, but rather incorporate all associated costs and charges into the base rent amount.

Increases in the cost of the lease over time

Just as additional outgoings can have a major impact on the total cost of your lease, rent reviews (or rent increases) over the course of your lease can amount to an excessive cost that you may not have budgeted for.

Some ways that the rent may be increased, is by:

Movements in CPI;
A fixed percentage (eg. 3%); or
A fixed amount (eg. $100).

The frequency of increases will vary too. Your lease might stipulate that the rent is to be reviewed 6 monthly, annually, or every 3 years. While a 3% increase every three years may be acceptable to you, it may be excessive if it applies every 6 months.

It is worthwhile to calculate the cost of the rent in real dollar values overtime as the lease goes on, so you get an accurate picture of what the lease will cost in year 1, year 2, year 3 and so on. The cost of the lease in year 3 might be vastly different to the cost in year 1 – particularly if you had lease incentives during the first year.

Don’t be afraid to negotiate if you feel the rent increase provisions to be out of your budget or excessive.

Options to renew the lease

It can be devastating to spend considerable time and money cultivating a business presence at the location of your rented premises, only to find out the lease has ended and the landlord requires you to move out. You don’t want to find yourself on the street before having time to recoup the money you’ve outlaid to fit-out the premises and set up your business there.

Make sure that you have a sufficient lease ‘term’ and options to renew the lease, once the initial term has expired, should you choose to stay on.

For example, you might have a 5 year initial lease term with 5 options to renew, each for an additional 5 year period. In this case, you would effectively have the right to lease the premises for 30 years, should you wish to do so.

Each situation is different and what suits one business may not suit another – so think about what’s right for you.

Maintaining the premises

Does the lease require you to undertake or contribute towards maintaining the premises, such as painting every 5 years, garden maintenance, etc. This will all add your overall out-of-pocket costs. Make sure the landlords’ requirements in this regard are fair and within reason – not to mention within your budget!

Assigning or subletting

Don’t get stuck with a lease that you can’t assign or sublet if your circumstances change.

Assigning your lease allows you to sign it over to someone else for example, if you sell your business.

Subletting the whole or part of your premises is different. This means you are still responsible under your lease to the landlord, but have a separate contract with a sub-tenant, who agrees to pay you rent. You can sublet part of the premises if you are not using the whole space (for example, in times of economic downturn) or you can sublet the whole of the premises (for example, if your business has grown forcing you to move on to a bigger location).

Generally speaking, assigning or subletting is a means for you to exit the lease arrangement should your circumstances require.

A standard provision allows you to assign or sublet with the landlord’s consent, but prevents the landlord from withholding their consent unreasonably. An acceptable reason for the landlord withholding consent may be if the proposed new tenant or sub-tenant does not have viable business experience or cash back-up.

Improvements to the premises

Make sure you can make alterations to the premises with the landlord’s consent. You should make sure that the lease stipulates that the landlord cannot unreasonably withhold its’ consent to any requested improvements that you may need to make to the premises.