When you are entering into commercial lease for the first time you may be confronted with a range of different components you have not yet considered with regard to your business premises.
A commercial lease, when drafted and negotiated carefully, can form a crucial part of your business and can also be cost effective tool, particularly if you are just establishing your name and service offering.
Here are some key terms to be mindful of and how to ensure they are negotiated fairly.
It goes without saying that one of the most fundamentally important aspects of a commercial lease is the amount you will pay for use of the premises. Rent reviews are also another essential area to be familiar with. Almost all commercial leases will include an annual rent review, however, you can try to negotiate the term if you would prefer it were less frequent.
The four main methods for calculating and implementing a rent review are:
- market rent;
- fixed percentage increase;
- fixed amount; and
- consumer price index (CPI).
Term of the lease
How long you lease a premises for can be a very important business decision. Too short a term can mean having to spend money moving to another premises (and be burdened by the logistics involved with the move), but too long of a term can mean locking yourself into a contract that may not be advantageous for the business.
If you are starting a new business, consider the time it will take to build up a strong client base and how this may be affected if you are forced to move on too soon, or how a long lease may not work for you if your business is dynamic and location sensitive. It is also important to assess the area around the premises to ascertain if it is subject to any upcoming construction or developments that may hinder trade.
Option to renew
Successfully running a business from a particular location and then having to move because there was no option to renew could be devastatingly difficult to recover from. That is why it is important that you only agree to a commercial lease that includes a fair option to renew.
Without this clause (or by agreeing to unfair renewal terms) you may find yourself having to leave the premises despite wanting to continue to operate out of them. Be sure that your lease agreement clearly states how and when you must exercise the option. Typically, this is in writing and is anywhere between three and six months prior to the completion of the initial term. If you do not exercise the option you are at risk of your lease not being renewed.
Alterations and additions
It is typical for a commercial tenant to fit out the premises to match how their business operates, what it sells and who its target market is. Alterations are usually the responsibility of the tenant, but if negotiated well a landlord may agree to update the space or pay for painting, flooring, signage or fixtures, especially if the premises has been vacant for some time. Some landlords may even offer a rent-free period for the time it takes for the alterations to be completed.
Maintenance and repairs
Landlords are usually responsible for the cost of any major works being undertaken on or associated with the building, including structural works or repairs to the air conditioning or roof, however, smaller repairs and maintenance are usually the responsibility of the tenant.
It is essential that you have a clear understanding about which party is responsible for repairs and maintenance prior to signing a lease. Unless otherwise agreed, it is likely that the tenant will be expected to take care of maintenance and repairs on any internal surfaces such as the floor and fixtures provided by the landlord as well as any fixtures the tenant has installed themselves.
Prior to agreeing to the terms of the lease it is prudent to engage a third party to inspect the premises with the objective of having them prepare a condition report. This report can later be relied upon in the instance a dispute arises over maintenance, what constitutes wear and tear and what is damage or a failure to maintain the premises.
Permitted and prohibited use
It is common to find clauses pertaining to ‘permitted’ or ‘prohibited’ use in a commercial lease. The purpose of these clauses is to stipulate what type of business activity you are permitted to use the premises for and what business you cannot operate in the space. Permitted use clauses may also cover the types of goods and services your business is permitted to sell and provide.
When negotiating your commercial lease, it is important to ensure this clause is broad enough that you are not locked in or limited to only offering a particular service on the chance you decide to expand your offering.
Permitted use clauses should also be viewed with the future possibility of subletting the premises or selling the business, and therefore should not be worded in a way that limits these opportunities.
Operating expenses and outgoings
Expenses such as land tax and water and council rates are the responsibility of the landlord. In some cases, depending on the location and type of premises, the landlord will also bear the costs of cleaning and security. These types of costs can often be the cause contention, so it is best to be absolutely clear about which party pays for what prior to signing a lease.
Are there any other clauses I need to be vigilant about?
You should be careful to check the lease for a clause relating to early termination, including any clauses that refer to redevelopment. Being forced to terminate the lease early isn’t just an inconvenience, it can also add unnecessary and unplanned costs to your business and cause interruptions, which can affect revenue or momentum while building your business. It is very important to try to have these types of clauses removed or to negotiate fair terms.
Some leases require the tenant to take out building or public liability insurance. This is not unusual, however, you should ensure that the lease does not also contain any indemnity clauses that state a requirement to compensate the landlord if any loss or damage occurs, as this could mean you are in breach of your insurance policy.
Be mindful of penalties attached to any default and breach clauses that are included in the commercial lease. These types of clauses are there to protect landlords against tenants who fail to pay their rent or let maintenance and repairs lapse. The landlord has the right to include clauses that remedy breaches and defaults, and it is the responsibility of the tenant to understand how they may be penalised.
Can the tenant make any inclusions?
Some business owners like to ensure certain clauses are included in a commercial lease. If a business is located within a shopping centre, for example, and has competitors operating in nearby locations it can affect revenue, so the inclusion of a clause such as an ‘exclusivity of trade’ clause can help protect a business from direct competition by offering exclusive entitlements to sell a particular product or service within the centre.
Retail leases and commercial leases, although both containing the aforementioned clauses, do differ slightly. A retail lease is reserved for premises such as shop fronts (as opposed to warehouses or offices where retail trade is not being undertaken) and comes with deeper protections from unconscionable conduct and misleading and deceptive conduct carried out by landlords.
Another key differentiator is that, in most states, landlords must bear the cost of having the lease prepared. Costs associated with the preparation of a commercial lease can usually be negotiated.
Finally, it is the landlord’s responsibility to provide the tenant with a disclosure statement. This statement should outline the costs and other information associated with the shop front being housed within a shopping centre. Failure to provide the document or disclose information gives the tenant the right to terminate the lease.
Negotiating a commercial lease can be delicate and overlooking the implications of clauses that affect operations or finances can have devastating effects on your power to run your business the way you would like. It is highly recommended that you seek legal advice before agreeing to the terms of a commercial lease. If you are require assistance negotiating the terms of a commercial lease we can help.